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DECLARATION

This is to certify that present project report entitled “ISLAMIC BANKING-MAKING A BETTER SOCIAL AND FINANCIAL WORLD “is based on my original research

work and indebtedness to other work duly acknowledged at relevant places.

The project report has not been submitted either in part or full for any other degree or diploma for any other University

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(Supervisor) (Student)

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ISLAMIC BANKING-MAKING A BETTER SOCIAL AND FINANCIAL WORLD

Project report submitted to Department of Commerce, Zakir Husain College, and University of Delhi in partial fulfillment of the requirement of B.Com (H) Part – III Examination.

Submitted by

SOOBIAN AHMED

B.Com (H) III yr. Roll No 07/546

2009-10

Under supervision

Of

DR.ABDUL WAHID FAROOQI

Department of Commerce

Zakir Husain College

University of Delhi

New Delhi-110002

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First of all I would like to express my gratitude to my Mentor, who guided me with

his knowledge and skill and helped me in successful completion of the work.

. ABDUL WAHID DRMentor and my I gratefully acknowledge my project guide

to the me leadsupport and guide that was provided to The .FAROOQI

successful completion of this project.

I am grateful to him for his great support and help all throughout the project. I am

thankful to him for taking out time and pointing out the multitudinous aspects of

Islamic banking and helping me increase my learning out of the project.

I would heartily thank all my friends without whose support & valuable inputs this

project would not have been completed.

B.Com (H) III yr. Roll No 07/546

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TABLE OF CONTENT

INTRODUCTION 6

BRIEF HISTORY OF BANK 7

INTEREST IS ONE OF THE MAIN SOURCE OF BANK’S INCOME 8

INTEREST A SOCIAL AND ECONOMICAL EVIL 9

1500 FARMERS COMMIT SUICIDE IN INDIA 10

INTEREST PROHIBITED IN ALL MAJOR RELIGION 11

WHY INTEREST IS PROHIBITED IN DIVINE LAW 16

INTEREST CAUSES INFLATION 19

HOW INTEREST FREE BANKING WORKS- A CASE OF JAK 22

DIFFERENCE BETWEEN ISLAMIC AND CONVENTAIL BANKING 29

PRINCIPAL OF ISLAMIC BANKING 30

BAHRAIN ISLAMIC BANK BALANCE SHEET 36

WHY ISLAMIC BANKING IS SUCCESFUL? -- By Prof. Rodney Wilson 40

THE ISLAMIC BANKING RECORD- Professor Rodney Wilson 41

ISLAMIC EQUITY FUND SEE RAPID GROWTH-Daniel Stanton 43

ISLAMIC BANKS GOING FORWARD : CHALLENGES 44

POSTSCRIPT ON THE CREDIT CRUNCH : 2009 46

ISLAMIC BANKING & RECISSION - By Mark Tutton 49

ISLAMIC BANKING AND INDIA 51

LIST OF ISLAMIC BANKS 63

BIBLIOGRAPHY 65

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INTRODUCTION

"People think the Islamic Banking system is based on faith, but it's based on justice. The system is based on justice for the two parties and how you get to the justice is extracted from Islamic faith"

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BRIEF HISTORY OF BANK:

The first state deposit bank, Banco di San Giorgio (Bank of St. George), was founded in 1407 at Genoa, Italy.

The name bank derives from the Italian word banco "desk/bench", used during the Renaissance by Florentine bankers, who used to make their transactions above a desk covered by a green tablecloth. However, there are traces of banking activity even in ancient times.

In fact, the word traces its origins back to the Ancient Roman Empire, where moneylenders would set up their stalls in the middle of enclosed courtyards called macella on a long bench called a bancu, from which the words banco and bank are derived. As a moneychanger, the merchant at the bancu did not so much invest money as merely convert the foreign currency into the only legal tender in Rome—that of the Imperial Mint.

The earliest evidence of money-changing activity is depicted on a silver drachm coin from ancient Hellenic colony Trapezus on the Black Sea, modern Trabzon, c. 350–325 BC, presented in the British Museum in London. The coin shows a banker's table (trapeza) laden with coins, a pun on the name of the city.

In fact, even today in Modern Greek the word Trapeza means both a table and a bank.

Traditional banking activities

Banks act as payment agents by conducting checking or current accounts for customers, paying cheques drawn by customers on the bank, and collecting cheques deposited to customers' current accounts. Banks also enable customer payments via other payment methods such as telegraphic transfer, EFTPOS, and ATM.

Banks borrow money by accepting funds deposited on current accounts, by accepting term deposits, and by issuing debt securities such as banknotes and bonds. Banks lend money by making advances to customers on current accounts, by making installment loans, and by investing in marketable debt securities and other forms of money lending.

Banks provide almost all payment services, and a bank account is considered indispensable by most businesses, individuals and governments. Non-banks that provide payment services such as remittance companies are not normally considered an adequate substitute for having a bank account.

Banks borrow most funds from households and non-financial businesses, and lend most funds to households and non-financial businesses, but non-bank lenders provide a significant and in many cases adequate substitute for bank loans, and money market funds, cash management trusts and other non-bank financial institutions in many cases provide an adequate substitute to banks for lending savings to.

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Interest is one of the main source of bank earning.

Apart from using your money to make more money by investing it... they can also lend

to individuals about 10 times what they receive.

i.e: If you deposit Rs10000 in the bank, the bank will be able to lend Rs10, 000 to Mr.

Sharma who just came after you... and they will charge Mr. Sharma interest on the Rs.10,

000... the bank does not need to have the money in cash to lend it out. In this case the

bank is happy to pay you 5% interest on the Rs.1,000 (Rs. 50 in one year) because if they

charge Mr. Sharma 8% on the Rs 10,000 they'll make in 1 year Rs.800... Total profit for

the bank Rs.800-Rs 50 = Rs.750.

A bank generates a profit from the differential between the level of interest it pays for

deposits and other sources of funds, and the level of interest it charges in its lending

activities. This difference is referred to as the spread between the cost of funds and the

loan interest rate.

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INTEREST A SOCIAL AND ECONOMICAL EVIL

In modern secular economic systems interest plays a very important role. In fact, in the

Western world people cannot think of any economic system without interest. From a

theoretical standpoint, interest has been a debatable subject among economic and political

theorists. Abu Saud defines interest as “the excess of money paid by the borrower to

the lender over and above the principal for the use of the lender’s liquid money over

a certain period of time”. Economists have presented different interpretations of

interest. Samuelson states that “Interest is the price of rental for the use of money”.

Don Patinkin gives the following definition: “Interest is one of the forms of income

from property, the other forms being dividends, rent and profit”. However, J.M.

Keynes did not define interest but mentioned the rate of interest as “The percentage of

excess of a sum of units of money contracted for forward units of time over the spot

or cash price of the sum thus contracted for forward delivery”

However, socialist and a number of capitalist economists have questioned these

explanations on both theoretical and technical grounds. They often stress the point that

money capital cannot be treated as capital goods on the same basis as productive

factors. It is pertinent to remark here that lending of money for interest was abhorred

and, in most cases, prohibited by all the monotheistic religions.

An eminent Western economist, Roy Harrod, regards the abolition of interest is the only

way to avert a collapse of capitalism. Not only this, but he speaks with great admiration

for an interest-less society in his work on Economic Dynamics. Harrod clearly

recognizes that, “It is not the profit itself, earned by services, by assiduity, by

imagination, or by courage, but the continued interest accruing from the accumulation

that makes that profit taker eventually appear parasitical…” and he further states that an

interest-less society which will be a totally new kind of society” would be the correct and

final answer to all that is justly advanced by the critics of capitalism.

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1,500 farmers commit mass suicide in India

Over 1,500 farmers in an Indian state committed suicide after being driven to debt by

crop failure.

The agricultural state of Chattisgarh was hit by falling water levels.

"The water level has gone down below 250 feet here. It used to be at 40 feet a few years

ago," Shatrughan Sahu, a villager in one of the districts, told Down To Earth magazine

"Most of the farmers here are indebted and only God can save the ones who do not

have a bore well."

Mr Sahu lives in a district that recorded 206 farmer suicides last year. Police

records for the district add that many deaths occur due to debt and economic

distress.

In another village nearby, Beturam Sahu, who owned two acres of land was among those

who committed suicide. His crop is yet to be harvested, but his son Lakhnu left to take up

a job as a manual labourer.

His family must repay a debt of 3000 and the crop this year is poor.

"The crop is so bad this year that we will not even be able to save any seeds," said

Lakhnu's friend Santosh. "There were no rains at all."

"That's why Lakhnu left even before harvesting the crop. There is nothing left to harvest

in his land this time. He is worried how he will repay these loans."

Bharatendu Prakash, from the Organic Farming Association of India, told the Press

Association: "Farmers' suicides are increasing due to a vicious circle created by

money lenders. They lure farmers to take money but when the crops fail, they are

left with no option other than death."

Mr Prakash added that the government ought to take up the cause of the poor farmers just

as they fight for a strong economy.

"Development should be for all. The government blames us for being against

development. Forest area is depleting and dams are constructed without proper planning.

All this contributes to dipping water levels. Farmers should be taken into consideration

when planning policies," he said.

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---INTEREST PROHIBITED IN ALL MAJOR RELIGION-----

INTEREST PROHIBITED IN ISLAM The word “Riba” is used in the Holy Quran 8 times. In 30:39,4:161,3:130, 2:276,2:278 and 3 times in 2:275. The Quran says: “Those who devour usury will not stand except as stand one whom the Evil one by his touch Hath driven to madness. That is because they say: "Trade is like usury," but Allah hath permitted trade and forbidden usury. Those who after receiving direction from their Lord, desist, shall be pardoned for the past; their case is for Allah (to judge); but those who repeat (The offence) are companions of the Fire: They will abide therein (for ever).” (Quran 2:275) “O ye who believe! Devour not usury, doubled and multiplied; but fear Allah. that ye may (really) prosper.” (Quran 3:130) “O ye who believe! Fear Allah, and give up what remains of your demand for usury, if ye are indeed believers. If ye do it not, take notice of war from Allah and His Messenger. But if ye turn back, ye shall have your capital sums: Deal not unjustly, and ye shall not be dealt with unjustly.” (Quran 2:278-279) If you are dealing in interest. Please do not expect angels to come down with swords to wage a war against you. It is talking about the severity of the sin. For other sins like alcohol, gambling etc. the Quran says: “O ye who believe! Intoxicants and gambling, (dedication of) stones, and (divination by) arrows, are an abomination,- of Satan's handwork: eschew such (abomination), that ye may prosper.” (Quran 5:90) Here the Quran says that intoxicants and gambling are Satan’s handiwork and abstain from it. In the case of Riba (Interest) the Quran does not only say that it’s a sin but it says that Allah (SWT) and his messenger Muhammad (pbuh) will wage a war against. Showing how grave this sin really is. Prophet Muhammad (pbuh) said: Prophet Muhammad (pbuh) classified it among the seven major sins” Volume 8, Book 82, Number 840: Narrated Abu Huraira: The Prophet said, "Avoid the seven great destructive sins." They (the people!) asked, "O Allah's Apostle! What are they?" He said, "To join partners in worship with Allah; to practice sorcery; to kill the life which Allah has forbidden except for a just cause; to eat up usury (Riba), to eat up the property of an orphan; to give one's back to the enemy and freeing from the battle-field at the time of fighting and to accuse chaste women who never even think of anything touching chastity and are good believers." Some may argue that only the taking of interest is prohibited. But one Sahih Hadith says “· Hazrat Jabir r.a. has reported that the Messenger of Allah cursed the devourer of usury, its payer, its scribe and its two witnesses. He also said that they were equal (in sin).” (Mishkat-ul-Masabih)

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INTEREST PROHIBITED IN BIBLE

“Do not charge your brother interest, whether on money or food or anything else that

may earn interest.” (Deuteronomy 23:19)

“Do not take interest of any kind from him, but fear your God, so that your

countryman may continue to live among you.” (Leviticus 25:36)

“If you lend money to one of my people among you who is needy, do not be like a

moneylender; charge him no interest” (Exodus 22:25)

Righteous servant of God doesn’t take interest

"Suppose there is a righteous man who does what is just and right. He does not eat at the

mountain shrines or look to the idols of the house of Israel. He does not defile his

neighbor's wife or lie with a woman during her period. He does not oppress anyone, but

returns what he took in pledge for a loan. He does not commit robbery but gives his food

to the hungry and provides clothing for the naked. He does not lend at usury or take

excessive interest. He withholds his hand from doing wrong and judges fairly between

man and man. He follows my decrees and faithfully keeps my laws. That man is

righteous; he will surely live, declares the Sovereign LORD. (Ezekiel 18:5-9)

But the violent one will take it

"Suppose he has a violent son, who sheds blood or does any of these other things

(though the father has done none of them): "He eats at the mountain shrines. He defiles

his neighbor's wife.

He oppresses the poor and needy. He commits robbery. He does not return what he took

in pledge. He looks to the idols. He does detestable things. He lends at usury and takes

excessive interest. Will such a man live? He will not! Because he has done all these

detestable things, he will surely be put to death and his blood will be on his own head”

(Ezekiel 18:10-13)

Jesus Christ came to fulfill the Law. He said:

“Think not that I am come to destroy the law, or the prophets: I am not come to destroy,

but to fulfill. For verily I say unto you, till heaven and earth pass, one jot or one tittle

shall in no wise pass from the law, till all be fulfilled. Whosoever therefore shall break

one of these least commandments, and shall teach men so, he shall be called the least in

the kingdom of heaven: but whosoever shall do and teach them, the same shall be called

great in the kingdom of heaven. For I say unto you, that except your righteousness shall

exceed the righteousness of the scribes and Pharisees, ye shall in no case enter into the

kingdom of heaven.” (Mathew 5:17-20)

The prohibition of usury was adopted as a major campaign by the earliest Christian

Church, following on from Jesus' expulsion of the money-lenders from the temple.

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The decrees of the Hebrew Bible were revived and a new reference to usury in the New

Testament was added. Based on the authority of those texts, the Catholic Church of the

4th century AD banned the clergy from charging interest, a rule that was later extended in

the 5th century to the laity.

In the 8th century, under Charlemagne, usury was declared a criminal offense. The

anti-usury movement gathered force in the late Middle Ages and reached its peak in 1311

when Pope Clement V totally banned the practice and declared null and void all

secular law defending it.

In spite of subsequent papal and legislative bans, loopholes in the law and contradictions

in the Church's arguments began to appear. Soon, on the rising tide of commerce, the pro-

usury movement began to grow. The rise of Protestantism and its pro-capitalist slant

strongly influenced change. However while both Luther and Calvin expressed

reservations about the practice of usury, neither condemned it outright.

Calvin, for example, cited seven situations in which interest was 'sinful'. These were

largely ignored however and his position interpreted as a general sanctioning of charging

interest. As a result of these influences, around 1620, according to the theologian Ruston,

'usury passed from being an offense against public morality, which a Christian

government was expected to suppress, to being a matter of private conscience, and a new

generation of Christian moralists redefined usury as excessive interest'.

Nevertheless, the ancient criticisms continue to pervade the Church's modern thinking, as

suggested by the viewpoint of the Church of Scotland (1988) when it released a report on

the ethics of investment and banking.

'We accept that the practice of charging interest for business and personal loans is not in

itself incompatible with Christian ethics. What is more difficult to determine is whether

the interest imposed is just or excessive' said the report.

In the same vein, it is interesting to contrast the clear moral mandate expressed through

Pope Leo XIII's Rerum Novarum (634-644 AD) about 'ravenous usury' as 'a demon

condemned by the Church but practized in a deceitful way by avaricious men,' with Pope

John Paul II's encyclical Solicitude Rei Socialis (1987) which omits any explicit mention

of usury, except for a vague reference to recognizing the Third World debt crisis.

This 'demon' governs current global relations, condemning most of the world

population to living under the sign of debt: i.e., each person born in Latin America

owes already $1,600 in foreign debt; each individual being conceived in Sub-Saharan

Africa carries the burden of a $336 debt, for something that its ancestors have long

ago paid-off. In 1980 the Southern countries' debt amounted to $567 billion; since

then, they have paid $3,450 billion in interests and write-offs, six times the original

amount. In spite of this that debt had quadrupled by the year 2000 reaching $2,070

billion.

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INTEREST PROHIBITED IN JUDAISM

Judaism's criticisms of usury are rooted in several passages of the Old Testament in which charging interest is scorned, discouraged and prohibited. The Hebrew word for interest is neshekh, which means 'bite' (though in Leviticus tarbit and marbit are also used), and it is believed to refer to the charging of often exorbitant interest (from the debtor's perspective).

In the Hebrew books of Exodus and Leviticus the ban is thought to be applied exclusively to loans to the poor and the sick, while in Deuteronomy, it extends to all loans, excluding trade with foreigners. The word 'foreigner' is interpreted in general as 'enemy' and, armed with this text, Jews employed usury as a weapon, as other people's needs could be transformed into submission.

Beyond these biblical roots, there are several Talmudic extensions of the bans on interest, known as avak ribbit -literally 'the dust of interest', which is applied for example to certain types of sales, rent or work contracts. It is distinguished from the rubbit kezuzah, interest adjusted over a quantity or a rate agreed between the lender and borrower. The legal difference is that the latter, if the debtor pays the lender, is recoverable from the lender, while the former, once paid, is not recoverable, though it is recognized that a contract sullied by the dust of interest may not be fulfilled.

In spite of the ban, this rule does not appear to have been observed in biblical times. In addition to the various references in the Old Testament to lenders who are rigidly exacting high interest rates, it can be seen in the Elephantine Papyrus (dating to the reign of Tuthmosis III) that among the Jews of Egypt in the 5th century BC it was the norm for interest to be charged for loans. This suggests that the violation of the ban was not seen as a criminal offense with a penal sanction, but as a moral transgression.

This can also be partially explained by the change in economic conditions, beginning in the Amoraim period in Babylonia (200-500 AD), when the prohibition against interest was agreed when usury became incompatible with the community's economic needs.

At the same time, a standard way of legalizing interest was established, known as hetter iska. This referred to the permission to create partnerships, which has become so common that today all transactions with interest are made openly according to Jewish law, simply adding to the corresponding note or contract the words al-pi hetter iskah.

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INTEREST PROHIBITED IN HINDUISM & BHUDDAISM

The oldest references to usury are found in religious manuscripts of India, dating back to 2000-1400 BC where the 'usurer' is associated with any interest lender. In the Hindu Sutra (700-100 BC) as well as in the Buddhist Jatakas (600-400 BC) there are many references to the payment of interest, along with expressions of disdain for the practice.

Vasishtha, a prominent lawmaker of the era, drafted a law that banned the high caste Brahmans and Kshatryas from being usurers or money-lenders. In the second century AD, the term usury becomes relative, meaning that interest above the legal rate could not be charged; that would be a usurious loan. But usury in some form or other has continued to the present day, and although in principle it is condemned, the term 'usury' refers only to exorbitant interest, ie well above socially accepted rates. The practice operates in most parts of the world.

INTEREST PROHIBITED IN WESTERN PHILOSOPHY

Many of the early Western philosophers including Plato, Aristotle, Cato, Cicero, Seneca and Plutarch were critics of usury. In the legal reforms of the Roman Republic (340 BC), usury and interest were banned. However, in the final period of the Republic, the practice was common. Under Julius Caesar, a limit of 12 per cent was imposed due to the great number of debtors, and under Justinian it was set at a mean between 4 per cent and 8 per cent.

In the Book, the FUTURE OF MONEY, Bernard lietar, he expertly highlights the intrinsic danger of Interest and then mentions how Islam has admirably represented the last bastion of resistance. He illustrates how interest is direct cause of inflation, wealth imbalance contributing rich getting richer and poor getting poorer.

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WHY INTEREST IS PROHIBITED IN DIVINE LAW?

It is worth to present an example to start with the subject, a factual example from existing interest based banking methodology that is valid and current, which can be well understood by a common person. One should consider the following facts before going through the example. The facts are:

Only Banks create money.

The created money is then supplied in to the economy only in the form of loan at some specified interest.

There are no other institutions that create money other than banks.

As all the banks are creating money and supplying in to the economy on interest and without any doubt all of them are practicing the same technique, so let us consider there is only one bank in our example that creates some money and supply in to the people's economy.

Suppose Bank XYZ creates Rs.1, 00,000 and supplies it at an interest rate of 10% per annum to several entrepreneurs and governmental units active in the economy remember there is no money available in the economy from any other source. The bank has taken substantial collateral or guarantee as security of its money from each borrower. See in the following diagram - the borrower’s intake loan and repayment liabilities at the end of the first year:

It is very simple and clear that at the end of the first year, a combined sum of Rs.1,10,000 is due on all borrowers to repay to the loaning bank.

But the money available in the economy is only Rs.1, 00,000 as the bank is only supplier of money, so from where the rest 10,000 would come that is the difference in the borrowers intake and total repayment amount...... from NOWHERE. Yes, that is right from nowhere because that money does not exist in the economy.

Look at the scene, the bank is the only supplier of money, it creates and supplies 1,00,000 in the economy and that is the total money available in the economy, but as per loan agreements - these borrowers collectively have to pay back 110,000. How is that possible? There is no way.

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Don't you believe, it is 100% like this - no less. This is cheating and criminal foul play. So what will happen, at least one or more of these borrowers would default on their loan(s) and would loose their personal assets or belonging that they had put as security to the bank for the repayment. The money creator has designed a mechanism that would force few of the borrowers each year to default so that bank could forfeit the security assets and gain wealth by foul play. This is an eye opening example for those who previously had no idea about the mechanism of banks as how they operate and cause artificial shortage (scarcity) of the money in the societies. This is happening every where in this world from USA to the smallest country on this beautiful planet. This artificial scarcity of money is the root cause of people's problems from hard struggle for surviving to the loss of happiness from their lives.

In a Riba (interest) based system, people are not aware of this foul play - borrowers think that they will manage to repay the principal plus Riba (interest) as they think it would be coming from some where else, but the fact is - every borrower would be in battle with others where some borrowers have to lose in order for others to win, some would fail to pay their loans in order for others to get the sum they need to pay off the Riba (Interest). When seen in totality, the supply side is always in deficit and the liability is always in excess due to Riba (interest), the total combined supply cannot discharge the liability.

After going through the above real example, I believe, now we are close to find out why Riba was declared Haram in all religion.

Let us begin with the economic reasoning of WHY:

1. The availability of each produce is limited, the liability cannot exceed the availability limit.

2. In any transaction, if a liability of produce "in excess" of "the produce available" is created, that extra liability would be artificial because excess quantity of produce does not exist.

This universal economic code applies to each and every type of produce; to further get in to the explanation of the rule, let us now identify what represents "the produce", "the transaction", and "extra liability":

The Produce

In its general expression "the produce" is any thing available to human beings for their use or consumption, but here specifically those produce that can be involved in a transaction, it is best to take historical standards of transactions which are based on produce like gold, silver, grains, currency etc. because throughout history all transactions are carried out in publicly acceptable produce only. These produce have served the societies as "medium of exchange", so it is more appropriate logically and historically to consider the produce as "the medium of exchange" which is again a general expression and can accommodate any other commodity/produce that may be used in a transaction.

The Transaction

In this universal economic principle, the transaction is based on a single produce and naturally it can only be a transaction of loan or exchange and nothing else. Although donations/grants also involve only one produce but that is not a transaction because a transaction means exchange of good(s) and/or service(s) either on spot or in any specified time frame involving one or more types of produce.

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Extra Liability

Riba (interest, usury) is that extra liability created in excess of the produce available and that does not exist. Every liability is a demand in practice, the basic rule of economics known to every one is that to maintain economic equilibrium (stability) in the society, the supply side should be equal to the demand, if the demand is more than the supply - a shortage will occur. Creating an extra liability means creating an extra demand without increasing equal supply, this will start a never ending mechanism of perpetually increasing the shortage of that produce in the society.

Conclusion:

Riba was prohibited just to prevent the creation of "extra liability/demand" because that is fake and "does not exist" physically, this artificial "extra liability/demand" creates scarcity of the produce in the society and unjustly accumulation of the produce in few hands. Riba (interest, usury) is a mechanism and dangerous weapon that has a power to get hold of assets/properties of individuals, enterprises, and nations deceitfully. This is unfair and against the nature, so ALLAH (SWT) banned Riba (interest, usury) very strictly to stop this criminal action.

A Just System

There is no doubt that a just system could only be designed by keeping the Islamic economic code at the heart of the system. This would only be possible when there will be a political will in the leadership. Muslim scholars and bankers have spent much time in designing many banking procedures and instruments according to Shariah that can expedite the transformation easily, but the question remains for the central governing system controlling the economy, the system may incorporate and accommodate the following:

The money creation should be the responsibility of the state.

The banks must invest only in equity investment.

The discounting should be explored such that it should serve as the driving force for the banks and the capital.

Riba (Interest) must be declared as crime in the society.

Few examples of Riba

To demonstrate the devastating power in the mechanism of Riba and the ignorance on the subject, following are few examples.

1. Suppose, if just One Gram of Gold (i.e., one millionth of a metric ton) was loaned at an interest rate of 2% p.a. at the time of first Hijri year (Islamic calender), then today (after 1422 Islamic years) the quantity of gold required to repay that loan would be 1,696,071.847 metric tons of gold, while the total gold reserve of the world known today (explored or unexplored) are less than 160,000 tons.

2. If a nation takes a loan of say US dollars one billion at an interest rate of 3% p.a., it would have to repay US dollars 4.3839 billion after fifty years. One can imagine the multiplying rate of Riba mechanism that had badly affected the economies of already weak nations.

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INTEREST CAUSES INFLATION

The argument of inflation is often advocated to compensate for the loss of value” or the “depreciation in money”, and therefore any consideration to offset this damage may well be justified. This approach may find its way fast in conventional organism, and to incorporate such computations may not be a problem in a mere profit driven interest based system rather it can be looked upon as another risk calculating element. However, it can’t and shall not go unchecked without proper evaluation for its Islamic permissibility; a viewpoint is required to be established off topic. Although, the same sense has traveled to many of Islamic minds as well except with a question mark, it equates to similar asking that an extra “equivalent to inflation” if charged by the lender will be considered as “Riba” or not? Here the problem is double, there is a well-known confusion on the subject of inflation in Western economies and when coupled with the prevailing confusion on the subject of “Riba” in Islamic World – it becomes horrendous! At least there is a common settled perception that inflation is some sort of phenomenon related to the upward trend in prices, but there is no unanimous agreement on the definition or what causes inflation. A wide variety of somewhat segmented classifications is provided from different schools of thoughts and work groups, like: 1. Demand Pull Inflation (Demand Supply Phenomenon) 2. Cost Push Inflation (Due to increase in the cost of production/supply) 3. Built-in Inflation (Result of past events experienced now) 4. Hyperinflation (Inflation getting out of control), etc.

You may find different variants of definition in English dictionaries, and few are generous enough to accommodate even sentimental statement within definition like "in inflation everything gets more valuable except money" but the acuity is matching all across. In dynamic societies / economies, when some happening or any phenomenon is observed influencing the economy or society then to keep the system ongoing, the management drive also institutes and enforces controlling mechanisms. Since the exact and agreed upon cause(s) of inflation are not identified, therefore the subject is also handled segment-wise to a certain extent. A proof for this partial handling is the formation of different indexes like: 1. Consumer Price Index (CPI) 2. Producer Price Index (PPI) 3. Employer Cost Index (ECI) 4. Purchasing Power (PP), etc. etc. There are many drawbacks connected naturally to indicators thus established from these indexes mainly because of the reason that these indexes do not cover every aspect but a weighted average of select group and therefore can not be reputed “as convincing as it demands” to deal with the problem. In addition to the statistics and analysis based on selected groups, there is an interesting circle that further deteriorates the credibility of these pointers, that is: 1. Use previous Price, Cost, and Purchasing Power etc. as reference. 2. Calculate Inflation from present Price, Cost and PP. 3. Prepare Reflection for the next. 4. Remember we are talking about inflation – the upward trend,

It is common and easy to understand that demand of certain things go high during some specific period or time or event, say for example “dates” are high-in-demand in the month of Ramadan, therefore prices are inflated. Shortage of products and commodities is certain in the times of wars thus prices are blown-up. What is difficult to understand is the situation where say, I am on my

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place for long; my city is calm, negligible change in habitants, increase in demand if any is met with the increase in supply, wages are not increased since last year, and lifestyle of the city people cannot change overnight. No reflective change in anything, no specific period or event is around, but prices are increasing in a regular pattern, a BIG WHY? This big why is regularized and justified with the contraption of “Inflation”. What inflation is? - Answer “7.2%” How calculated? - “from CPI which is …..” What causes inflation? - “may be blab bla bla!” Figures work simple is that, it works because mostly people are interested in figures, so even if nobody knows “what causes inflation” - it will not make a difference or just very little difference – at least the inflation figure is known, isn’t it interesting?

What causes Inflation? An adequate amount of literature on different explanations is there available on book-shelves and Internet; inflation is explained as a result of “excess money supply”, a result of “paper money”, an outcome of “increase in demand”, a burden derived from “over expenditure of government in the form of taxes” etc. Central banks seem more convinced with the cause of “excess money supply” (or may be because it is their jurisdiction and they can control it easily), anyway what ever is the reason of their persuasive cause, the adjustment they normally do is to squeeze money supply by increasing “interest rates” to fight “so-called inflation”. The monetary contraction and expansion policies are well known styles of central banks to address inflation and deflation respectively. What are the results of all these efforts taken in the context of “inflation”? I don’t know any but confusion. The every time successful strategy worked again, i.e., if you can’t answer or can’t do anything about a problem – try to confuse. But the monkey (if you know the story) was not succeeded in confusing the complainant by jumping from one tree to another (exerting efforts) in order to solve the problem of plaintiff. There are people in the society not satisfied with efforts or means undertaken to tackle inflation issue and the projections of its causes. What causes inflation is still not answered to their satisfaction. Although, the mentioning of “interest” as a relative of “inflation” is seen, but “Riba or Interest” is not labeled as the main cause of producing inflation which in my view is the “true story”. How and why? “Riba or Interest” AS THE “Cause of Inflation” In order to explain how “Riba or Interest” becomes the main cause of Inflation, it is mandatory to further elaborate my point of view about “Riba” that revolves around the “non-existence” of the extraliability created in a transaction. At a given time of transaction when a lender and a borrower are going to agree on interest based loan contract, there is an owner of each penny of capital available in the economy. Is there a contract executed at that moment with similar time span in the economy to bring about the “change of ownership of capital” equivalent to the “Riba or Interest” in favour of borrower? Because of the deficit he is in now due to the just concluded agreement. No need of such a simultaneous contract, might be argued in a case where the borrower already owns equivalent to that extra he has committed in terms of “Riba or Interest” and is able to discharge his total liability. Any problem now, YES! Still there is. Whatsoever is the case, the borrower owns that much or not, his commitment or promise is reflected in accounting books of lender in “receivable” column and “balance sheet projection with increase of profit”. Is there any manifestation of the contract on the part of borrower? Yes, of course there will be. The books of borrower will be adjusted for an

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increased liability, the assets side will be re-evaluated to balance or to gain profit (profit is the motive every where, means and rules are subjective), a check on options available to the borrower to match the increased liability will sound only to adjust the saleable assets prices upward. If “Riba or Interest” was not there in the contract; absolutely there was no requirement to adjust accounting books, and therefore no forced increase in the prices of saleable assets (inventory). From this single case in point, one can expand the canvas to every type of financial contract incorporating “Riba or Interest”, the “receivable” of lender is always reflected as increased liability on accounting books of the borrower (an industrialist, trader, service provider, individual etc.), accounting adjustment of that “increased liability” is only possible by upward price adjustment of products and services. It can happen at the start of the business, in midway or whenever “Riba or Interest” is recorded in books. Here, the whole economy is run like this, lending is taking place on regular basis incorporating “Riba or Interest”, prices are increased with each cycle of lending, there is a continuous trend of increase in prices, study CPI and other bunch of indexes, regard it as empirical evidence but please don’t call it a phenomenon of “Riba or Interest” but “Inflation”. It looks simple; true as well “the root cause of inflation is the practice of incorporating Riba or Interest in lending”. This is totally opposite to the belief (or mistaken belief) posed by central banks. When central banks adopt the policy of “increasing interest rates”, it gives an impression that by increasing interest rates, the inflation is reduced or at least capped from further increase in it, you heard this and kept in mind, but you can’t be convinced because there is no logic told.

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How interest-free banking works

The case of JAK

By- Ana Carrie

Can a bank operate successfully if it does not charge interest on its loans? The Swedish JAK Medlemsbank (Members’ Bank) certainly does – it has been called the safest bank in Sweden. This account of how it does so is based on two visits to its headquarters in Skövde and numerous conversations with JAK’s enthusiastic staff and members, both in Sweden and in Ireland. I am indebted to the staff of JAK for their hospitality and assistance, and to Feasta for its financial support. Savings Points JAK’s primary objective is to provide its members with interest-free loans. In order to accomplish this, it must attract interest-free savings. JAK uses a system of “Savings Points” in order to balance saving and borrowing. Given the choice of borrowing without interest or saving without interest, most of us would gladly choose borrowing. While people are generally willing to save temporary surpluses of money in current accounts that don’t pay interest, few are willing or able to save more significant amounts over a long period of time with no compensation. JAK cannot, of course, lend money without having savings on deposit and so, using an Imaginative system of Savings Points, each member who wishes to take out a loan must save Money first and, over a lifetime with JAK, every member will have saved roughly as much money and for the same period of time as they will have borrowed. You could almost imagine JAK as Allowing its members to borrow (interest-free) from their future selves. For a new JAK member, the first step towards an interest-free loan is to save and thereby earn Savings Points. These are calculated as the amount saved, multiplied by the number of months for which it is saved, multiplied by a Savings Factor. This factor varies according to the type of savings account the member has selected and is lower (about 0.7) for a demand account from which savings can be withdrawn at any time. For example, assuming a Savings Factor of 0.9, we have1: €100 1 Month 0.9 = 90 Savings Points The Savings Factor varies with the type of deposit account and is lowest for demand accounts where savings can be withdrawn at any time (about 0.7). Example 1: Either of these scenarios would earn identical Savings Points.

After saving for a minimum of six months, a member may apply for a loan. In order to borrow €1 for one month, one Savings Point must be redeemed. The amount borrowed and the time taken

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to repay are entirely up to the member, provided that the appropriate Savings Points are available. For example, borrowing €90 (or €9,000) over 1 year uses as many savings points as borrowing €45 (or €4,500) with repayments spread over 2 years.

Example 3: An alternative basic loan, borrowing half as much but repaying it over a longer period.

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In addition to a Basic Loan that uses Savings Points already earned, members may apply for an Additional Loan using Savings Points that will be earned in the future. An “Allocation Factor” (currently 14) is multiplied by the member’s current Savings Points to determine the number of points available for an Additional Loan. Each loan repayment includes a savings installment, and the payments are structured so that when the loan is fully repaid, all necessary Savings Points have been earned. A consequence of this is that upon full repayment of an Additional Loan, the member has built up significant savings. Savings made during the course of repaying a loan are known as Post-Savings, while those that precede the loan are Pre-Savings. Once the loan has been repaid, the balance of the post-savings is available to the member to be withdrawn or, as frequently happens, to be used as the start of saving for a new loan.

Example 4: A Basic Loan with an Additional Loan There is no interest charged on a loan, of course, but members must place 6% of the value of the loan on deposit for the duration of the loan, and additionally pay a loan fee to cover administration costs. Members also pay 200 SEK (about €22) when they first join JAK and 200 SEK per year as a membership fee. JAK is a virtual bank in the sense that it has no branches and business cannot be transacted in person. A necessary and prudent decision since the membership of JAK is quite spread out over a large country, and also resulting in no bias against rural members who would have to travel much farther to their nearest branch. A result of this “virtual” status is that JAK members must have an account with another bank with which to conduct their day-to-day financial affairs. Members transfer money into or out of their JAK basic account via post giro, bank giro or Internet into their other accounts. With improvements in technology and the changing financial infrastructure, JAK hopes in the near future to offer direct deposit of pay cheques and credit/debit card facilities to its members. For some members, this might negate the need to bank elsewhere.

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Credit control Like any bank, JAK must ensure that loans can and will be repaid. Unlike most banks, however, JAK’s system of saving and borrowing has several unique features that combine to give it an enviably low default rate. A member applying for a loan is given a range of options for the loan size and duration based upon their desired loan amount, desired repayments and available savings points. When they have made their selection, the loan department within JAK must assess the member’s ability to repay the desired loan. The member’s income and expenses are evaluated with the assistance of computer software that calculates average living expenses for individuals and families based upon age and gender. Between 20 and 25 applications are processed per week, and 95% are approved. Most loans are secured, either against property or with a personal guarantor. Loans for up to 37,000 SEK (about €4,000) with 2-5 years’ duration can be unsecured, but these are limited to 5% of JAK’s turnover and so surplus applications must be held in a queue until funds are available. The most common reason for borrowing is to refinance a conventional bank loan obtained to buy a house followed by purchasing a car and making home improvements. In general, people who can save regularly are good performers when it comes to loan repayments. The JAK system where saving must precede borrowing is therefore ideally suited to attracting these regular savers. In addition, around half-way through repayment of a loan there is a break-even point where the Post- Savings on deposit are equal to the balance outstanding on the loan and from this point forward the loan is fully secured by the member’s savings.

Very few JAK loans end in default. Borrowers are decidedly involved “members” as opposed to disinterested “customers”. Many feel quite strongly about the idea of interest-free banking and this common bond goes a long way towards encouraging good behavior. Personal guarantors rarely need to be asked to make good on their guarantee. Liquidity At the simplest level, a bank takes one person’s savings and lends them to someone else. Ideological arguments aside, this presents some practical difficulties. Firstly, what if a saver wants their money back before the borrower has finished with it? Secondly, what if there are not enough or too many borrowers relative to savers? The first point is generally dealt with in the banking system by having a reasonably large number of savers and making sure that enough

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money is set aside to cope with those who, on any given day, want some of their money back. While individuals might withdraw their savings in a random manner, a large group of savers will tend to be stable and predictable. It is JAK’s policy to keep a minimum of 20% of pre-savings available in either a bank account or in government bonds, either of which can be made available almost immediately. Too much liquidity means that money is lying idle rather than being lent out to members, so it is not seen as desirable to have much more than 20% on reserve. Post-savings do not need to have a component on reserve since these can only be withdrawn at specified times. JAK also encourages stability from its savers by offering a higher Savings Factor in long-term deposit accounts. JAK members can choose from 6, 12 and 24-month deposit accounts which represent the advance notice required to make a withdrawal. With regard to the second point, JAK has a more difficult balancing act between saving and borrowing than other banks, due to the fact that the two are intimately linked by Savings Points. Most people save with the intention of borrowing in the future. An excess of saving today could indicate too much demand for borrowing next year. The Allocation Factor has a central role in the relationship between supply of savings and demand for loans. In general, the JAK board sets the Allocation Factor to reflect the current level of liquidity within the bank. The greater the pool of excess savings, the higher the Allocation Factor to encourage members to take out loans and reduce the excess. Unfortunately for JAK, the relationship between the Allocation Factor and the demand for loans is not as simple as this. In the short term, increasing the Allocation Factor can actually make things worse, as members decide to increase their Savings Points with a view to taking out a larger loan in the future. Excess demand for loans would be particularly problematic for JAK. Reducing the Allocation Factor would likely lead to an outcry from members who had made financial plans based on a higher factor. The alternatives, however, would be to refuse more loans or to introduce a waiting list. The dynamics of this saving/borrowing relationship are likely to be a constant challenge to JAK’s management as the membership grows and the range of banking services offered by JAK expands. JAK culture A significant amount of JAK’s energy is devoted to communicating with its 21,000-strong membership. JAK is a co-operative, fully owned by its members. In addition to a quarterly newsletter, 24 regional offices staffed by trained volunteers keep in touch with members through study groups and exhibitions. While JAK’s primary function is to provide interest-free banking, it is also viewed by the membership as a vehicle for economic reform. A recent innovation in support of economic reform is the Local Enterprise Bank. Community members save in a special JAK account and, rather than earning points themselves, their savings are used to provide an interest-free loan for a local enterprise. Savings are fully guaranteed, so members are not exposed to any financial risk. The first two projects to be funded in this way are an ecological slaughterhouse and a replica Viking village. It is an interesting experiment in local finance for local projects, and so far has been very warmly received by local media and participants. While savers don’t, of course, receive any interest on their savings, they benefit both economically and otherwise from the improvements in their local economy and infrastructure as a result of the projects. Conclusions The JAK Members’ Bank is unique in the commitment it inspires from its volunteers and staff. It provides affordable and responsible finance, and enables its members to have a say in where their money is invested. I have no doubt it will continue to be true to its purpose and values while exploring new frontiers in ethical finance.

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Why interest-free banking matters

Does it matter whether a bank charges interest or not? After all, every bank has to charge for its services or it won’t stay in business. Interest is simply the way that banks calculate the charge they make for the service they render when they approve a loan and for the risk they take on by doing so. Why shouldn’t the charge be based on the amount of money involved, the time for which it’s being lent and the demand for money at the time? Doesn’t that method of calculation seem fair? As Ana Carrie shows in her article, even the JAK Bank charges an arrangement fee for approving a loan and then an annual fee every year for as long as that loan is on its books. If these charges were expressed as an interest rate, they would work out at about 3%. That seems cheap until you realize that JAK requires its borrowers to lend it the sum that they borrow for an equivalent length of time. This means that, while they are lending to the bank, customers lose roughly the same amount of interest that they would have paid, net of the 3% service charge, if the JAK had been an ordinary bank and had charged them interest when they were borrowing. So if the JAK system merely involves people losing on the swings what they gain on the roundabouts, why are the bank’s members so enthusiastic about it? One reason is that some believe that the charging of interest sets up a growth compulsion in the economy and that, as perpetual economic growth is unsustainable; the development of a no-interest banking system is a key step towards building a sustainable economy. The roots of this type of thinking run back to the time when gold was used as currency. Since gold did not increase itself, and very little was being mined, where, people asked, was the extra bullion to come from to pay the interest when both principal and interest had to be handed over at the end of the year? Obviously, the borrower could only obtain more gold if someone else had less, so lending money at interest meant that either the borrower impoverished himself when he paid over the extra or he impoverished someone else. And, as neither outcome was socially desirable, usury, as all forms of money lending were called no matter how low the interest rate, stood morally condemned by both the Roman Catholic Church and by Islam. Even though we now use paper currencies, this source-of-interest problem has not gone away. Since almost all money in circulation is issued on loan, the money to cover interest payments can only be obtained by borrowers if other borrowers have borrowed sufficiently more. Moreover, the necessity to pay interest on these additional borrowings means that the economy needs to expand if the proportion of world income which is paid over in interest to the lenders is not to increase. But let’s look at this argument a little more closely. How much is ‘sufficiently more’? Not all the interest paid over to the banks gets withdrawn from the stock of money in circulation. Some of it is returned to the stock right away by being paid as interest to the people from whom the banks themselves are borrowing money. Some returns by being paid to cover the banks’ operating costs, such as their wages bill. And the amount paid in dividends to the banks’ shareholders goes back into the stock too. So only the fraction of the interest paid that ends up as the banks’ retained earnings has to be borrowed back into the system. This is not a serious problem. If inflation was allowed to run at about 2.5% a year, that would be enough to allow the ratio between the level of outstanding loans and national income to be held constant. So, if one has a fairly relaxed attitude to inflation, the charging of interest is not a serious component of the growth compulsion. If the JAK bank made a surplus one year and increased its reserves, it would be just as much a part of the problem as its commercial, interest charging, competitors. Other members of JAK have more sophisticated reasons for giving the bank their support. Oscar Kjellberg, the development director, is opposed to charging interest because it transfers wealth from the poor to the rich and from declining areas - often rural ones - to more prosperous parts. “That sort of transfer doesn’t happen with JAK,” he says. “People save with us because they

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either want to borrow interest-free themselves or because they want to assign the right to an interest-free loan to a relative, a son or daughter, perhaps or to an organization they support. This means that most money is lent out in the same area that it was collected, and, if it’s not, it’s only loaned in a place and for a purpose which the original saver has approved.” In other words, perhaps the most important reason for backing JAK-style interest-free banking is that it limits a dangerous, destabilizing positive feedback built into the present economic system. The feedback occurs because prosperous parts of the world get more investment because better returns can be had from projects there, which makes them still more prosperous, while poorer areas have what capital they possess taken away because no good projects can be found. As a result, the poorer areas fall further behind and people living in them are forced to leave to seek work wherever investment is going on. They take up residence in the expanding areas and add their spending to its rising income flow, generating further investment possibilities. And so the cycle goes on. A major cause of the emigration of young people from rural Ireland used to be that their parents had allowed their savings to be invested away from home. A JAK bank would help prevent a recurrence of that situation. The JAK bank is a good example of a flourishing cooperative - the lenders and the borrowers and the owners of the bank are all the same people – engaged together in an independent enterprise which serves them all and accords with their beliefs. Although the services provided and the purposes for which loans are made are still fairly limited, these are expanding as Ana Carrie mentions at the end of her article. JAK is one of thousands of small cooperative banks around the world that confound the myth that financial services are best provided by the large capitalist institutions which dominate the mainstream financial services industry.

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Basic Differences between Islamic and Conventional Banking

Before we understanding the detailed differences between Islamic and conventional

banking products and transactions, it is important to know these broad differences:-

# Islamic banking only deals in “halal” products and services. Thus, all transactions must

be SHARIAH COMPLIANT i.e. must be in accordance with the Islamic Jurisprudence.

# Most Islamic Financing transaction is based on trading and deferred exchange contract,

whereas conventional banking loan product is granted on the basis of debtor and creditor

relationship. In short, Islamic bank relationship is regarded as “Financier &

Customer/Client” rather than “Lender & Borrower”. The only lender and borrower

transaction under Islamic banking is when the borrower (i.e. the Bank) grant interest free

loan under the principle of "Al-Qhad". Under this transaction, we expect the borrower to

repay the loan at no extra charges. But if it is granted based on "Al-Qhadhul Hassan", it is

lent based on benevolent basis i.e. if the borrower cannot pay, we should not be expected

to demand for repayment.

# The consideration of collateral to be looked upon separately. However, if the

transaction is based on "joint-venture" basis, there should not be any collateral;

# In a default or termination situation, the Bank (or financier) normally demand the

outstanding sale price. Generally, the sale price is fixed and comprise "principal and

profits" predetermined upfront before a contract is signed.

# compounding calculation i.e. to conventional practice of "interest upon interest"

element is strictly prohibited under Islamic banking system.

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PRINCIPAL OF ISLAMIC BANKING

Islamic banking has the same purpose as conventional banking except that it operates in accordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions). The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of riba (usury). Common terms used in Islamic banking include profit sharing (Mudharabah), safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah), and leasing (Ijarah).

In an Islamic mortgage transaction, instead of loaning the buyer money to purchase the item, a bank might buy the item itself from the seller, and re-sell it to the buyer at a profit, while allowing the buyer to pay the bank in installments. However, the fact that it is profit cannot be made explicit and therefore there are no additional penalties for late payment. In order to protect itself against default, the bank asks for strict collateral. The goods or land is registered to the name of the buyer from the start of the transaction. This arrangement is called Murabaha. Another approach is EIjara wa EIqtina, which is similar to real estate leasing. Islamic banks handle loans for vehicles in a similar way (selling the vehicle at a higher-than-market price to the debtor and then retaining ownership of the vehicle until the loan is paid).

An innovative approach applied by some banks for home loans, called Musharaka al-Mutanaqisa, allows for a floating rate in the form of rental. The bank and borrower form a partnership entity, both providing capital at an agreed percentage to purchase the property. The partnership entity then rents out the property to the borrower and charges rent. The bank and the borrower will then share the proceeds from this rent based on the current equity share of the partnership. At the same time, the borrower in the partnership entity also buys the bank's share of the property at agreed installments until the full equity is transferred to the borrower and the partnership is ended. If default occurs, both the bank and the borrower receive a proportion of the proceeds from the sale of the property based on each party's current equity. This method allows for floating rates according to the current market rate such as the BLR (base lending rate), especially in a dual-banking system like in Malaysia.

There are several other approaches used in business transactions. Islamic banks lend their money to companies by issuing floating rate interest loans. The floating rate of interest is pegged to the company's individual rate of return. Thus the bank's profit on the loan is equal to a certain percentage of the company's profits. Once the principal amount of the loan is repaid, the profit-sharing arrangement is concluded. This practice is called Musharaka. Further, Mudaraba is venture capital funding of an entrepreneur who provides labor while financing is provided by the bank so that both profit and risk are shared. Such participatory arrangements between capital and labor reflect the Islamic view that the borrower must not bear all the risk/cost of a failure, resulting in a balanced distribution of income and not allowing lender to monopolize the economy.

And finally, Islamic banking is restricted to Islamically acceptable transactions, which exclude those involving alcohol, pork, gambling, etc. Thus ethical investing is the only

acceptable form of investment, and moral purchasing is encouraged.

Islamic banks and banking institutions that offer Islamic banking products and services (IBS banks) are required to establish a Shariah Supervisory Board (SSB) to advise them and to ensure that the operations and activities of the bank comply with Shariah principles. On the other hand,

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there are also those who believe that no form of banking can ever comply with the Shariah. Malaysia, the National Shariah Advisory Council, which additionally set up at Bank Negara Malaysia (BNM), advises BNM on the Shariah aspects of the operations of these institutions and on their products and services. In Indonesia the Ulama Council serves a similar purpose.

A number of Shariah advisory firms (either standalone or subsidiaries of larger financial

groups) have now emerged to offer Shariah advisory services to the institutions offering

Islamic financial services. Issue of independence, impartiality and conflicts of interest

have also been recently voiced.

ISLAMIC BANKING TERMINOLOGY

1) Bai' al-inah (sale and buy-back agreement)

The financier sells an asset to the customer on a deferred-payment basis, and then the

asset is immediately repurchased by the financier for cash at a discount. The buying back

agreement allows the bank to assume ownership over the asset in order to protect against

default without explicitly charging interest in the event of late payments or insolvency.

Some scholars believe that this is not compliant with Shariah principles.

2) Bai' bithaman ajil (deferred payment sale)

This concept refers to the sale of goods on a deferred payment basis at a price, which

includes a profit margin agreed to by both parties. This is similar to Murabahah, except

that the debtor makes only a single installment on the maturity date of the loan. By the

application of a discount rate, an Islamic bank can collect the market rate of interest

3) Bai muajjal (credit sale)

Literally bai muajjal means a credit sale. Technically, it is a financing technique adopted

by Islamic banks that takes the form of murabaha muajjal. It is a contract in which the

bank earns a profit margin on the purchase price and allows the buyer to pay the price of

the commodity at a future date in a lump sum or in installments. It has to expressly

mention cost of the commodity and the margin of profit is mutually agreed. The price

fixed for the commodity in such a transaction can be the same as the spot price or higher

or lower than the spot price. (Deferred-payment sale)

4) Mudarabah (profit sharing)

Mudarabah is an arrangement or agreement between the bank, or a capital provider, and

an entrepreneur, whereby the entrepreneur can mobilize the funds of the former for its

business activity. The entrepreneur provides expertise, labor and management. Profits

made are shared between the bank and the entrepreneur according to predetermined ratio.

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In case of loss, the bank loses the capital, while the entrepreneur loses his provision of

labor. It is this financial risk, according to the Shariah, that justifies the bank's claim to

part of the profit. The profit-sharing continues until the loan is repaid. The bank is

compensated for the time value of its money in the form of a floating rate that is pegged

to the debtor's profits.

5) Murabahah (cost plus)

"Mudarabah" is a special kind of partnership where one partner gives money to another

for investing it in a commercial enterprise. The investment comes from the first partner

who is called "rabb-ul-mal", while the management and work is an exclusive

responsibility of the other, who is called "mudarib". This concept refers to the sale of

goods at a price, which includes a profit margin agreed to by both parties. The purchase

and selling price, other costs, and the profit margin must be clearly stated at the time of

the sale agreement. The bank is compensated for the time value of its money in the form

of the profit margin. This is a fixed-income loan for the purchase of a real asset (such as

real estate or a vehicle), with a fixed rate of profit determined by the profit margin. The

bank is not compensated for the time value of money outside of the contracted term (i.e.,

the bank cannot charge additional profit on late payments); however, the asset remains as

a mortgage with the bank until the Murabaha is paid in full.

This type of transaction is similar to rent-to-own arrangements for furniture or appliances

that are very common in North American stores.

6) Musawamah

Musawamah is the negotiation of a selling price between two parties without reference by

the seller to either costs or asking price. While the seller may or may not have full

knowledge of the cost of the item being negotiated, they are under no obligation to reveal

these costs as part of the negotiation process. This difference in obligation by the seller is

the key distinction between Murabaha and Musawamah with all other rules as described

in Murabaha remaining the same. Musawamah is the most common type of trading

negotiation seen in Islamic commerce.

7) Bai salam

Bai Salam means a contract in which advance payment is made for goods to be delivered

later on. The seller undertakes to supply some specific goods to the buyer at a future date

in exchange of an advance price fully paid at the time of contract. It is necessary that the

quality of the commodity intended to be purchased is fully specified leaving no

ambiguity leading to dispute. The objects of this sale are goods and cannot be gold,

silver, or currencies based on these metals. Barring this, Bai Salam covers almost

everything that is capable of being definitely described as to quantity, quality, and

workmanship.

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8) Ijarah thumma al bai' (hire purchase)

Parties enter into contracts that come into effect serially, to form a complete lease/

buyback transaction. The first contract is an Ijarah that outlines the terms for leasing or

renting over a fixed period, and the second contract is a Bai that triggers a sale or

purchase once the term of the Ijarah is complete. For example, in a car financing facility,

a customer enters into the first contract and leases the car from the owner (bank) at an

agreed amount over a specific period. When the lease period expires, the second contract

comes into effect, which enables the customer to purchase the car at an agreed to price.

The bank generates a profit by determining in advance the cost of the item, its residual

value at the end of the term and the time value or profit margin for the money being

invested in purchasing the product to be leased for the intended term. The combining of

these three figures becomes the basis for the contract between the Bank and the client for

the initial lease contract.

This type of transaction is similar to the contractum trinius, a legal maneuver used by

European bankers and merchants during the Middle Ages to sidestep the Church's

prohibition on interest bearing loans. In a contractum, two parties would enter into three

concurrent and interrelated legal contracts, the net effect being the paying of a fee for the

use of money for the term of the loan. The use of concurrent interrelated contracts is also

prohibited under Shariah Law.

9) Ijarah-wal-iqtina

A contract under which an Islamic bank provides equipment, building, or other assets to

the client against an agreed rental together with a unilateral undertaking by the bank or

the client that at the end of the lease period, the ownership in the asset would be

transferred to the lessee. The undertaking or the promise does not become an integral part

of the lease contract to make it conditional. The rentals as well as the purchase price are

fixed in such manner that the bank gets back its principal sum along with profit over the

period of lease.

10) Musharakah (joint venture)

Musharakah is a relationship between two parties or more, of whom contribute capital to

a business, and divide the net profit and loss pro rata. This is often used in investment

projects, letters of credit, and the purchase or real estate or property. In the case of real

estate or property, the bank assess an imputed rent and will share it as agreed in advance.

All providers of capital are entitled to participate in management, but not necessarily

required to do so. The profit is distributed among the partners in pre-agreed ratios, while

the loss is borne by each partner strictly in proportion to respective capital contributions.

This concept is distinct from fixed-income investing (i.e. issuance of loans).

11) Qard hassan/ Qardul hassan (good loan/benevolent loan)

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This is a loan extended on a goodwill basis, and the debtor is only required to repay the

amount borrowed. However, the debtor may, at his or her discretion, pay an extra amount

beyond the principal amount of the loan (without promising it) as a token of appreciation

to the creditor. In the case that the debtor does not pay an extra amount to the creditor,

this transaction is a true interest-free loan. Some Muslims consider this to be the only

type of loan that does not violate the prohibition on riba, since it is the one type of loan

that truly does not compensate the creditor for the time value of money.

12) Sukuk (Islamic bonds)

Sukuk is the Arabic name for a financial certificate but can be seen as an Islamic

equivalent of bond. However, fixed-income, interest-bearing bonds are not permissible in

Islam. Hence, Sukuk are securities that comply with the Islamic law (Shariah) and its

investment principles, which prohibit the charging or paying of interest. Financial assets

that comply with the Islamic law can be classified in accordance with their tradability and

non-tradability in the secondary markets.

13) Takaful (Islamic insurance)

Takaful is an alternative form of cover that a Muslim can avail himself against the risk of

loss due to misfortunes. Takaful is based on the idea that what is uncertain with respect to

an individual may cease to be uncertain with respect to a very large number of similar

individuals. Insurance by combining the risks of many people enables each individual to

enjoy the advantage provided by the law of large numbers.

14) Wadiah (safekeeping)

In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in

the bank and the bank guarantees refund of the entire amount of the deposit, or any part

of the outstanding amount, when the depositor demands it. The depositor, at the bank's

discretion, may be rewarded with Hibah as a form of appreciation for the use of funds by

the bank.

Shariah Supervisors

The Board of Directors to appoint a Shariah Supervisor, responsible for monitoring all

the Bank’s transactional procedures and assuring Shariah compliance.

Also the General Secretary of the Fatwa & Shariah Supervision Board, the Shariah

Supervisor handles queries about the Bank’s administration from staff members,

shareholders, depositors and customers, liaises with the Shariah auditors and provides

them with guidance. He submits reports and suggestions to the Fatwa & Shariah

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Supervision Board and to the Chairman of the Board of Directors. The position also calls

for participation in the Bank’s training programmes.

Shariah Auditing

The supervisory function forms a part of the Shariah Supervision procedures, its main

task being to check Shariah compliance under the guidance of the Shariah Supervisor.

The auditors continuously review the Bank’s transactional procedures to ensure

adherence to the framework created by the Fatwa & Shariah Supervision Board. The

Shariah auditors submit periodic reports to the Shariah Supervisor so as to monitor and

maintain Shariah compliance.

Islamic equity funds

Islamic investment equity funds market is one of the fastest-growing sectors within the Islamic financial system. Currently, there are approximately 100 Islamic equity funds worldwide. The total assets managed through these funds currently exceed US$5 billion and is growing by 12–15% per annum. With the continuous interest in the Islamic financial system, there are positive signs that more funds will be launched. Some Western majors have just joined the fray or are thinking of launching similar Islamic equity products.

Despite these successes, this market has seen a record of poor marketing as emphasis is on products and not on addressing the needs of investors. Over the last few years, quite a number of funds have closed down. Most of the funds tend to target high net worth individuals and corporate institutions, with minimum investments ranging from US$50,000 to as high as US$1 million. Target markets for Islamic funds vary; some cater for their local markets, e.g., Malaysia and Gulf-based investment funds. Others clearly target the Middle East and Gulf regions, neglecting local markets and have been accused of failing to serve Muslim communities.

Since the launch of Islamic equity funds in the early 1990s, there has been the establishment of credible equity benchmarks by Dow Jones Islamic market index (Dow Jones Indexes pioneered Islamic investment indexing in 1999) and the FTSE Global Islamic Index Series. The Web site failaka.com monitors the performance of Islamic equity funds and provide a comprehensive list of the Islamic funds worldwide.

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Why Islamic Banking Is Successful?

- By Prof. Rodney Wilson

The collapse of leading Wall Street institutions, notably Lehman Brothers, and the subsequent global financial crisis and economic recession, are encouraging economists world-wide to consider alternative financial solutions. Attention has been focused on Islamic banking and finance as an alternative model. What lessons can be learnt, and how resilient have Islamic banks been during the current crisis?

Islamic Banking Principles And Sub-prime Lending

The religious teaching underpinning Islamic finance is concerned with justice in financial contracts to ensure that none of the parties is being exploited.

Riba( interest or usury) is one source of exploitation, especially, as in the case of sub-prime lending, the highest rates were charged to lower earners. Such discriminatory charging by conventional banks was justified as being a reflection of the risks involved.

Those on lower incomes, with poorer prospects of finding new employment in the event of redundancy, were less likely to be able to service their interest payments.

Islamic housing finance involves risk sharing between the bank and the client, rather than transferring all the risk to the latter. Under the most commonly used diminishing musharaka (partnership) contract, the bank and the client form a partnership, with the bank providing up to 90 percent of the purchase price, and the client at least 10 percent.

Over a period of usually 10 to 25 years, the client buys out the ownership share of the bank which makes its profit from the rent paid by the client for the share the bank owns.

In the event of a rental or repayments default, the bank may advance the clients an interest-free loan (qard hassan in Arabic) to enable them to continue their payments during the recession in anticipation that they will pay in full when the economy rebounds. The client retains their home rather than being faced with eviction— like the victims of the sub-prime crisis.

Of course Islamic banks have to appraise credit risk, and indeed are more cautious about who they should finance than conventional banks. The banks in the United States charged high arrangement fees for sub-prime borrowers which were used to pay bonuses for those signing up new clients.

As the mortgages were sold on to Freddie Mac and Fanny Mae, the arrangers were unconcerned that the sub-prime borrowers might be unable to meet their financial obligations. Indeed, gifts were provided to entice the feckless to sign up, and the mortgages often exceeded the value of the property. The banks in other words became mere booking agents, with no long term commitment to their clients.

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The Islamic Banking Record

In contrast to conventional banks, no Islamic bank has failed and has needed government

recapitalization which ultimately becomes a burden on hard pressed taxpayers.

All Islamic banks comply with the Basel II capital adequacy requirements and the Islamic Financial Services Board (IFSB)- the body which advises regulators with respect to Islamic finance- has produced detailed guidelines on compliance. The IFSB has an on-going relationship with the Bank for International Settlements-the institution which developed the Basel standards- and is certain to be consulted as Basel III guidelines are drafted for capital adequacy which are likely to be implemented globally in the coming decade.

The soundness of Islamic banks is accounted for by the fact that they use a classical banking model, with financing derived from deposits, rather than being funded by borrowings from wholesale markets. Consequently when the credit crunch came and borrowing from wholesale markets was halted, Islamic banks were not exposed. However, Islamic banks are not immune from the effects of the global recession, and the fall in oil prices will inevitably have a negative impact on 2008 results of Gulf-based Islamic banks. The situation will become clearer from February once the audited financial statements start to appear.

Two Islamic housing financial institutions, Amlak and Tamweel are being merged, as both have faced problems given their exposure to the Dubai property market.

In Iran where all financial operations have been shariah-based since the Law on Usury Free Banking was introduced in 1983, banks have been relatively insulated from the financial crisis, ironically because United States sanctions meant they could not deal with institutions such as Lehman Brothers which were trying to place large amounts of toxic debt with Middle Eastern banks. The sanctions therefore proved to be a blessing in disguise for Iran— although the Islamic banks there have been adversely affected recently by the fall in gas prices.

Nevertheless being state owned, institutions such as Bank Melli, the largest Islamic bank in the world, are well placed to ride out the global financial storm. With assets of over $50 billion, and 2007 profits exceeding $540 million, it has more than adequate resources to cope.

Islamic Financial Stability

Islamic banks enjoy a built-in stabilizer to help them cope with economic downturns, as instead of paying interest to depositors, those with investment mudaraba accounts share in the banks profits. Thus, if profitability declines in an economic downturn, depositors receive lower returns, but if profits rise they enjoy higher returns.

This profit sharing reduces risk for the banks and means they are less likely to become insolvent. However as the banks build up a profit equalization reserve, which can be used to finance pay-outs during difficult years, depositors benefit from some protection of their returns during economic downturns.

The last year has been difficult, if not disastrous, for equity investors, given the fall in stock market prices globally.

Investors in equities screened for shariah compliance have also suffered, but less than their conventional counterparts, because they have not invested in the shares of riba-based banks which have fared especially badly during the global financial turmoil.

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Investors seeking Shariah compliance have portfolios which are more heavily weighted in sectors such as healthcare or utilities where revenue streams are maintained even during cyclical down-turns.

Prospects for Islamic Finance

Islamic banking provides a viable alternative to conventional banking and is less cycle prone. The spread of Islamic finance into western markets demonstrates that it now being treated seriously by regulators and finance ministries.

There are already five wholly Islamic banks in London, and the first Islamic bank will open in France in 2009. According to the conservative estimates of the Banker in October 2008, Islamic financial assets globally exceed $500 billion, a figure that could easily double over the coming decade. The experience of Islamic banking in the United Kingdom has been extremely positive. Islamic Bank of Britain has been operating as a retail bank for over four years, and has attracted over 40,000 customers. HSBC Amanah, the Islamic finance subsidiary of HSBC, has been operating for ten years in London, focusing mainly on institutional clients and business finance.

Alburaq, the Islamic finance subsidiary of Arab Banking Corporation, has become the market leader for shariah compliant home finance in the United Kingdom. None of these institutions has been affected by the global financial crisis, and their resilience bodes well for the future.

Sukuk Are Real Assets

In addition to banking, Islamic sukuk security issuance has enormous potential. Unlike conventional bonds and notes, sukuk are backed by real assets, which provides assurance to investors .Although global sukuk markets were adversely affected by the global recession in 2008, longer term prospects look promising, with the United Kingdom authorities promoting London as an international centre for sukuk issuance to rival Bahrain, Dubai and Kuala Lumpur.

The Malaysian ringgit sukuk market has been largely unaffected by the global turmoil in securities markets, and issuers such as the Saudi Arabia Basic Industries Corporation, one of the world’s largest petrochemical producers, view sukuk as a desirable instruments to raise funding for plant expansion. There can be no doubt that Islamic finance has an exciting future, and the quest for a financial system based on moral values rather than greed and fear, is bound to enhance its position in the global system.

Professor Rodney Wilson is the Director of Postgraduate Studies, School of Government and International Affairs of Durham University. Prof. Wislon's research areas are Islamic economics and finance, Middle Eastern political economy, and The political economy of oil and gas. He wrote various books on Islamic economics.

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Islamic equity funds see rapid growth

-----Daniel Stanton on Monday, 18 February 2008

The Islamic equity funds industry has grown to around US$20 billion in assets under management, according to research released on Monday.

Failaka Advisors, a fund monitoring company, said that Islamic equity funds had grown rapidly in recent years, driven by GCC investors.

Tariq Al-Rifai, chairman of Failaka, said: "The size of this market has tripled over the past five years."

Funds investing in the GCC market represent more than half of the entire Islamic equity fund industry. Saudi Arabian funds and fund managers dominate the industry, accounting for nearly 75 funds out of around 300 Islamic equity funds worldwide. Bahrain has become the favored centre for fund registrations in the Gulf, with institutions such as Kuwait's Global Investment House and Saudi Arabia's National Commercial Bank having established fund management operations there recently.Failaka reported that in 2007 the best performing Islamic equity fund managed in the GCC was Saudi British Bank's Amanah GCC Equity fund, which delivered a return of 83.2%.

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Islamic banks going forward: challenges

The continuing rapid growth of demand for Islamic financial services is clearly good

news for Islamic banks. At the same time, it also presents some challenges, as the banks

need to invest in upgrading their credit risk management capabilities in line with the more

complex and larger projects into which they are entering.

Despite the rapid growth, business models and products of Islamic banks are still rather

homogeneous, while Shari’ah compliance amplifies risks stemming from product

configuration and process implementation. The success of Islamic banking in recent years

has produced too many Islamic banks with the same business models. There is a lack of

‘bread and butter’ lending, and the current excess liquidity has led to too much

complacency among Islamic banks.

In addition, there is a large and diverse set of accounting standard differences across

different jurisdictions. The development and setting of simple standard legal contracts is

necessary in order to overcome the complexity and heterogeneity of current contracts.

Furthermore, the deployment of IT systems that help monitor the fulfillments and

visibility of processes on an end-to-end basis are crucial to facilitate the continuous

monitoring of activities by Shari’ah scholars while eliminating the possibilities of non-

compliance, which in some cases might render transactions invalid.

Liquidity risk management of Islamic banks is an important challenge and is constrained

due to limited availability of tradable Islamic money market instruments and weak

systemic liquidity infrastructure. At the moment, there is no Shari’ah-compliant short-

term Islamic money market (less than one week maturity) in local currency or in US

dollars, and Islamic repo markets have not yet developed. Islamic money markets with

longer maturities, which are based on commodity murabaha transactions (mark-up

financing), sometimes suffer from unreliable brokers with low creditworthiness. Islamic

banks also have a competitive disadvantage with conventional banks, as they deposit

their overnight money with their domestic central bank interest free. The lack of liquidity

and viable alternatives, combined with the competitive disadvantage, hamper the local

Islamic banks and can even create a liquidity crisis.

Islamic banks going forward: solutions and opportunities

Both risk managers and regulators are working to address the above challenges. To

overcome the shortcomings of the Islamic money market, many investment banks are

currently designing new complex products, compliant with Shari’ah law. It remains to be

seen whether these new solutions will obtain widespread Shari’ah-compliant status in the

Islamic finance community, and generate enough demand for a functional Islamic money

market to develop.

The rapid developments are likely to continue. Financial institutions in countries such as

Bahrain, the UAE and Malaysia have been gearing up for more Shari’ah-compliant

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financial instruments and structured finance – on both the asset and liability sides. At the

same time, the leading financial centers, such as London, New York and Singapore, are

making significant progress in establishing the legal and prudential foundations to

accommodate Islamic finance side-by-side with the conventional financial system. Many

of the largest western banks, through their Islamic windows, have become active and

sometimes leading players in financial innovation, through new Shari’ah-compliant

financial instruments that attempt to alleviate many of the current constraints such as a

weak systemic liquidity infra-structure. More conventional banks are expected to offer

Islamic products, enticed by enormous profit opportunities and also ample liquidity,

especially across the Middle East.

New product innovation is also driven by domestic banks’ interest in risk diversification.

With a large number of new Islamic banks across the Middle East and Asia especially,

diversification of products enables banks to offer the right product mix to more

sophisticated clients. A few banks are already active across different jurisdictions, and

this trend is certainly going to continue in the near future, possibly with some

consolidation.

On the regulatory front, the Islamic Financial Services Board (IFSB), an international

standard-setting organization based in Malaysia, has moved ahead with its efforts aimed

at fostering of the soundness and stability of the Islamic financial services industry

through more standardized regulation. Globally accepted prudential standards have been

adopted by the IFSB that smoothly integrate Islamic finance with the conventional

financial system. For instance, the adoption of the IFSB standards (somewhat akin to

Basel II), which take into account the specificities of Islamic finance, ensures a level

playing field between Islamic and conventional banks.

Many challenges still lie ahead, as is clear from the discussion above. However, the

ongoing improvements in banks’ risk management techniques and prudential frameworks

for Shari’ah-compliant banking give reasonable hope that the Islamic financial industry’s

growth will contribute positively to broader financial and economic stability.

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POSTSCRIPT ON THE CREDIT CRUNCH, 2009

Underlying this had been a rise in US interest rates between 2004 and 2005 from 1% to 5.35%, resulting in high levels of default at the “sub-prime” end, which is to say, the high risk end of the housing market. Because mortgage lenders had sold on their debts via hedge funds to other financial institutions, the consequence of irresponsible lending spread contagiously through banking systems, especially in the West, as house prices started to fall and the real estate asset value underpinning the loans became negative. When BNP Paribas told its investors that they would not be able to draw money out of two of its funds owing to a “complete evaporation of liquidity” it was the start of a domino effect, forcing governments to step in and avert potentially catastrophic runs on major banks.

From the perspective of usury which we now revisit more than a decade after its first publication in 1998, we find it instructive to reflect on how far such problems can be laid at the door of an interest-based banking system. Full consideration of this is beyond our current scope, but in this postscript we will confine ourselves to making three brief observations.

First, the credit crunch was a consequence of the preceding credit bubble inevitably bursting. In certain Western countries, including Britain and America, governments had deregulated financial agencies to an extent where irresponsible lending became normalized. For example, in Britain, through until 2008, it was easy for people to get mortgage loans on property of 120% of the property value with few questions asked. Property prices were rising sharply, the global economy was booming, and traditional banking caution was thrown to the wind. People re-mortgaged their homes to pay off credit card debts that carried very high rates of interest, and which had been sold to them by aggressive marketing. People had started to believe that ever-rising house values and continuing economic good times would generate property values that would continuously outstrip their liabilities. Far from failing to dispel this notion, leading lenders exploited it. City staffs were rewarded with massive “fat cat” bonuses based on the size and quantity of loans made. Concerns about their overall quality of lending portfolios were silenced through hedging – the selling on and spreading out of risk on speculatively buoyant markets.

While everybody played the game and interest rates remained low the system appeared to be working. It met investor expectations with high rewards. But as US interest rates rose in a necessary effort to counteract the economic knock-on effects of house price inflation, the consequences of having bought into a usurious and greed-driven system started to hit home. Loan default rates reached the point of crisis. Those who were able to see it coming, mostly the wealthy and well-advised who had a greater variety of financial options open to them, were able to bail out in time. Those who had been caught with little option if they wanted to buy a house to live in were squashed – leaving many young families now struggling to pay off debts as their house values fell into negative equity. As the media rightly observed, Wall Street’s gains are Main Street’s losses, with the negative externalities of financial speculation passed on to society as a whole.

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We might learn from this that an economics that canonises greed, lays in store catastrophic weaknesses that will eventually hit the poor hardest.

Our second point is that globalisation, whilst creating massive new economic wealth from deregulated trade, has reduced resilience in the world financial system. Fire walls between different countries’ economies that were held in place by measures such as controls on foreign currency transactions substantially fell away in the years that followed the “new right” economics of Reagan and Thatcher. Enabled by computerised production planning and stock control, new notions of just-in-time commercial supply systems profitably maximised economic efficiency. But there was a hidden cost. It also reduced the resilience that slack allows in highly interdependent chains of supply. Without slack, supply networks, like the socio-ecological systems on which they depend, become brittle. They become prone to breaking rather than bending when placed under stress. And for a monetarily based economic supply system, a bank running out of liquidity is like a car suddenly losing its oil. Devoid of lubrication the engine grinds to a sudden halt. That was why, in 2008, governments were left with no option but to bail out the banks.

This loss of resilience is what distinguishes the current situation from the bank crashes of the 1920s. Back then, society and especially its food production was less industrialized. People lived closer to the land. Most essential services such as food production were local production for local consumption. But today, essential chains of supply are long, often global, and therefore subject to international market and financial vagaries. A glimpse of the consequences of such dependency can be seen from what happened in Britain in September 2000 when fuel tanker drivers went on strike. Within five days, panic buying emptied some supermarket shelves and the media carried sporadic reports of fighting at the checkouts. The Blair government, fearing civil unrest, capitulated. Applied to the situation in 2008, we might ask much more unrest might have broken out if bank failure had resulted in the sudden loss of financial lubrication with its consequent immediate knock-on effects?

We might learn from this that the risks are too high for governments to wash their hands of regulating modern economies. Unfettered free markets expose the very fabric of civil society to the law of the jungle on a bad day. Overly deregulated markets can only be transient phenomena, like handing out free pizza. Because of their abstract nature based on confidence – the word means “faith together” – financial markets are all the more volatile. The brazenness by which financial engineers or rather, marketers, tried to spread risk by creating derivative “products” driven ultimately by mortgage interest rates and their effect on property values reveal a massive collapse of responsibility. That collapse happened because faith shifted from having direct equity connection to tangible assets onto abstract financial connections that could be many times removed and diluted from the reality on the ground. Such derivatives had become ships of fantasy. Devoid of anchors, they drifted fecklessly with no bearings on the landmarks of reality until the rocks struck.

Our third observation is that many people ask whether the “credit crunch” (the term sounds disarmingly like a packet of breakfast cereal, with a free gift inside) signals the “end of capitalism”. On the contrary, we consider that it represents only a cyclical spasm in the process by which capitalism periodically restructures itself in a crash that most hurts the weak. The consequence of job losses and repossessions in the housing market are that the relatively disadvantaged, many now saddled with negative equity, will be forced long term to work harder to pay off debts, including their share of the national debt that will manifest in tax rises. As such, the creditors – many from their offshore tax havens - retain and reconsolidate a grip that they would not have had if their involvement in the process had been through risk-shared equity holdings, as with

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Islamic banking principles. These investors will, in future, be the people who find themselves in a position to buy up repossessed (which is to say, bankrupt) housing stock, and thereby strengthen their arm in future as rentiers to those who have lost out. The relatively poor will be forced to work yet harder on a treadmill that damages family life and with it, weakens the future fabric of society

.

Capitalism can be understood at many different levels, from honest trade and entrepreneurialism all the way to its advanced Anglo-American casino version. In the latter, the role of money undergoes a shift. It changes from its primary role as a means of recording and lubricating exchanges of goods and services. It takes on second order abstract qualities of being speculative. Here money alone generates more money, and the principle of usury – defining it as the lending of money at real positive rates of interest (i.e. rates greater than what is needed to cover inflation and risk) – is the inner wheel driving the system.

Although we believe capitalism in one form or another is here to stay, the "credit crunch" may go down in history as the most serious challenge yet to financially speculative advanced capitalism. Henceforth electorates and their governments should give more determined consideration to the oligarchic principle of allowing so much power and latitude to shareholders and their financial analysts whose investment motivation is purely to ‘play the market’.

2009 will probably mark the point at which the pendulum starts to swing back to more carefully and strongly regulated financial markets. As it turns out, this approach is entirely consistent with the philosophy of the iconic economists Adam Smith (who was after all a ‘moral philosopher’) and John Maynard Keynes (who warned against the dangers of speculative activities). Ironically, these are often cited by neo-liberal market fundamentalists in support of their ideological deregulatory stance. Any of us who have knowingly participated in usury-related casino economics share the responsibility for what has happened. Whilst neither of the current writers is a Moslem, we cannot help but be reminded of the Islamic hadith that states: “The taker of usury and the giver of it and the writer of its papers and the witness to it, are equal in crime.” To put it in the language of other Abrahamic religions, we have worshipped at the shrine of Mammon, the god of wealth. Mammon has now transmogrified into Moloch – the fire-filled hollow stone god of the Hebrew Bible. Into his lap the children were reputedly

sacrificed … and that, in the name of idolatrously seeking future economic prosperity.

Through the lens of such metaphor the “credit crunch” must, like the “climate change crunch”, be understood spiritually, or in terms of deep values. It is our consumer greed that has driven the problems now faced. Whatever our religious background if any, the crises of present times can be seen as a spiritual, or a values-based wake-up call. As such, modernity may still have something to learn from the ancients.

Alastair McIntosh & Wayne Visser-January 2009

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Islamic banking and recession By Mark Tutton, For CNN

LONDON, England (CNN) -- With irresponsible banking practices taking the blame for bringing about the global economic crisis, there has been a surge of interest in Islamic finance. Islamic finance is estimated to be worth $700 billion and has been growing by 15 to 20 percent per year.

Now, a slew of academic courses are springing up to meet the demand of those wanting to break into an expanding market. According to ratings agency Moody's, the global Islamic finance sector is worth $700 billion and has the potential to be worth $4 trillion.

What's more, the ethical principles underpinning Islamic finance are seen by some as offering a more sustainable alternative to profit-oriented conventional banking. The result is that academic institutions are lining up to offer formal training in the area.” There is a huge demand for Islamic finance courses now, so large that it's difficult to cope with," Professor Habib Ahmed, Sharjah chair in the school of government and international affairs at Durham University, England, told CNN.

Durham will launch a Masters degree in Islamic finance from October, becoming one of a number of European institutions to offer Islamic finance programs.” Islamic finance has been growing by 15 to 20 percent per year for some time and there is a lot of interest at the moment. People are looking for alternatives after the economic crisis."

"Islamic economists believe that if the principles of Islamic finance were followed the crisis wouldn't have happened. We are seeing a lot of non-Muslim countries, including the UK, France, Japan, Hong Kong and Singapore encouraging Islamic finance," he said. There are many differences between Islamic and conventional banking practices. One fundamental difference is that Islamic banks do not charge interest. Rather than borrowers and lenders, the system is based on buyers and sellers.

"Conventional banking is biased to the seller. Islamic finance is trying to level the ethics between the two parties," Aly Khorshid, an Islamic finance scholar who writes for Islamic

Banking and Finance magazine, told CNN."People think the Islamic Banking system is based

on faith, but it's based on justice. The system is based on justice for the two parties and

how you get to the justice is extracted from Islamic faith," he said.

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Khorshid said that there are similarities between "ethical investment" schemes and Islamic finance, in that the Islamic system does not allow investment that harms people or the environment. He credits the rapid growth of the Islamic finance sector on the success of "sukuk"

-- Islamic bonds. In the West, banks including Lloyds TSB, HSBC, Deutsche Bank and Citibank all offer Islamic finance products, catering to a niche market of

Muslim borrowers.

But while Islamic banks allow Muslims to take advantage of financial services that are consistent with their religious beliefs, it is the ethics underpinning Islamic finance that are attracting the interest of conventional finance institutions keen to learn lessons from the banking crisis. Although Islamic banks have suffered from the global repercussions of the economic downturn, they emerged largely unscathed from the initial banking meltdown that brought about that financial turmoil.

Ahmed told CNN that is because Islamic banks are not allowed to deal in mortgage-backed securities or credit-default swaps, two of the practices accused of helping bring about the banking crisis.Khorshid said that although it's too early to say if Islamic finance has dealt with economic downturn better than conventional finance, the Islamic system has many more layers of risk assessment and management, which could help protect it from the problems afflicting conventional banks.

But the growth of Islamic finance has brought its own problems. Critics say some banks use Islamic finance to package what are essentially conventional products. "Islamic banks are also driven by the profit motive and sometimes that can dominate the ethics," Ahmed told CNN.

While Europe is catching up with the demand for these banking products, the U.S. is lagging behind. Ahmed says that regulatory and legal changes are needed for Islamic finance to grow in the U.S., but he adds there are signs that Canada may become a North American center for Islamic finance. The lack of Islamic finance services in the U.S. is reflected in a relative lack of demand for Islamic finance courses, but in the UK there is the opposite problem.

With students coming from Asia and the Middle East to get the qualifications that will help them take advantage of the Islamic finance boom, Ahmed says it is difficult for universities to find qualified teaching staff. "Most people with PhDs in Islamic finance are working in the industry, making a lot of money," he told CNN.

He added that Islamic finance products have the potential to appeal to the non-Muslims market, pointing out that in Malaysia the majority of customers for Islamic banks aren't Muslims.” If people look at the principles they'll see something beneficial in terms of economics, rather than just religious reasons. It's a type of ethical finance that may be attractive to a lot of people."

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of Islamic banking in India Feasibility

Current status of Islamic Banking in India

Islamic banks in India do not function under banking regulations. They are licensed

under Non Banking Finance Companies Reserve Bank Directives 1997 RBI

(Amendment) Act 1997, and operate on profit and loss based on Islamic principles. All

the Islamic banks have to be compulsorily registered with RBI.

Reasons for non implementation of Islamic Banking in India

In the straitjacket world of Indian banking, something as fascinating as Islamic banking is

a distant dream. Nonetheless, countless advocates of Islamic banking have been trying

their best over the years to propagate the concept. In furtherance of this propagation the

Reserve Bank of India (RBI) constituted a committee in 2007 to examine the issue but

viewed that Islamic banking cannot be offered by banks in India as well as the overseas

branches of local banks under the present legal framework. Except a basic offering like

current account, almost no other banking product in India can be modified to meet the

conditions of Islamic banking. As a genre of financial services, Islamic banking shuns the

very idea of interest rates, and rests on profit-sharing principles. Based on the Shariah

law, it abhors the business of making money out of money, upholding the belief that

wealth is generated through actual trade and investment. The RBI has not put the report

in the public domain.

While the final form of the report is not known, from the newspaper reports it can be

collected that the members had pointed out how Indian banking laws come in the way of

various Islamic banking principles. These are as follows:

1. n Al Wadiah (for saving bank account): Section 21 of the Banking Regulation Act

(BR Act) requires payment of interest on such deposits; thus, interest-free deposit and a

simple charging of premium or Hiba is not permissible.

2. Mudarabah (for term deposit or investment): Here again, Section 21 of the BR Act

disallows such products where the bank can invest the money in equity funds (in India,

52

equity exposure is determined by a separate set of rules), and the client has complete

freedom in the management.

3. Mudarabah, Musharakah (for project finance and SME credit): Sections 5, 6 of the

BR Act indicate the forms of business a banking company can undertake, and does not

allow any kind of profit-sharing and partnership contract the basis of Islamic banking.

4. Ijarah (for home finance) : As against Islamic banking where the banks owns the

asset and hold the title, Section 9 of the BR Act prevents the bank from any sort of

immovable property other than private use.

5. Instinsa (leasing, buyback): Besides the usual curbs on acquiring immovable

property, offering Islamic banking products many not are bankable due to stamp duty,

central sales tax and state tax laws that will apply depending on the nature of the transfer.

The BR Act even disallows an Indian bank from floating a subsidiary abroad to launch

such products, or offering these through a special window. Thus, the upshot of the

findings is that such banking experiment is impossible without a new law or multiple

amendments to the BR Act.

Another important consideration is the tax procedures. While interest is a passive

income, profit is defiantly an earned income which is treated differently. If principles of

Islamic banking are incorporated then how does it comply with the tax procedure is the

moot question. Furthermore RBI cannot act as the lender to such banks because such

accommodation by the monetary authority is also interest based. Islamic banks cannot

interact with conventional banks based on principles of interest.

Conclusion

Though it can be concluded that as of now RBI has stopped all the possibility of Islamic

banking in India (other than NBFCs), there are certain questions which remain

unanswered. The RBI report has not been made available on the public domain like other

reports are definitely one question waiting to be answered. If the international banks have

established Islamic merged it with their object of profit making why can the same be

done in India also is not answered. Keeping in mind the flourishment of Islamic

Banking all over the world and the Muslim population in India these are the questions

which have to be answered immediately and with certainty.

53

India High potential for Islamic banking in

Points of Essence:

India could be a significant market for Islamic banking institutions due to its

large Muslim population.

However it is still subject to a favorable change in regulatory environment

and increased awareness among Muslims and India.

NEW DELHI,: Given favorable regulatory conditions, India holds a promising growth

opportunity for Islamic finance institutions, whose asset base globally is expected to

more than triple to $1 trillion by 2016, a study says.

Islamic banking is already fast gaining prominence among the global financial

institutions, especially in the backdrop of the banking sector woes impacting the markets

like the USA and UK and the concept has a huge potential market in India as well,

according to market intelligence and data analysis services provider Grail Research.

India could be a significant market for Islamic banking institutions, provided there is a

favorable change in regulatory environment and increased awareness among Muslims

and India as a whole, said a report by Grail Research, part of US-based management

consultancy Monitor Group.

“You need to look no further than at the profitability of Saudi banks (the world’s highest)

for reasons why Islamic finance will have strong interest globally as a growth engine for

financial services,” Grail Research Founder and CEO Mr Colin Gounden said.

As per the Indian census, India has one of the largest Muslim population in the world but

a large portion of this has not been able to access the banking services because as per

Islamic principles, giving or receiving interest is prohibited though money can be lent on

profit sharing or fee based model.

“The size of the market will be very large as the Indian population is above 100 crore

and Muslim population itself is about 15 crore and majority of them, in the name of

religious faith, are looking for interest free banking and finance,” University of Calicut

professor AI Rahmatullah said. Under the current regulations, which do not allow banks

to keep deposits without paying interests or enter into profit sharing agreements with

clients, it is not possible for commercial banks to offer Islamic banking services in India.

To get a clear picture, let us analyze the position of Islamic banking in India on SWOT

(Strength, Weakness, Opportunity and Threat) Scale. SWOT analysis will help us to

logically examine the chances if this concept would flourish or flounder in India.

54

STRENGTH

Islamic Banking will unequivocally ameliorate the deplorable condition of the poor and

marginalized segments of society. Banking products which comply with Islamic law are

becoming increasingly popular, not only in the Gulf countries and far eastern states like

Malaysia, but also in other developed markets such as the United Kingdom. Reputed

banks like Standard Chartered, Citibank, HBSC are operating interest free windows in

several West Asian countries, Europe and USA. There is a huge potential market in India

for Islamic banking products.

Islamic banking helps the weaker and hapless section of the society through various

financial products. Islamic banking finances (through its Joint ventures, partnerships and

leasing)are provided by investors or banks to the borrowers with a condition that

financial risk is to be borne by the investors, and other risks to be borne by the borrower.

This helps even the indigent and vulnerable to get finance at a no risk and cost basis, but

definitely requires other credits like strong business proposal, rational planning, skilled

hands and specialized art to attract the financier. Better business proposals succeed in

fetching funds as opposed to the projects with comparatively poor propositions. Such

inclusive growth will aggrandize the Indian economy.

The high powered Raghuram Rajan Committee draft Report as released on 7th April

2008, strongly suggested interest-free banking as a part of recommendations made for

financial sector reforms. The Committee postulates that interest free banking is another

area that falls broadly in the ambit of financial infrastructure. Faiths prohibit the use of

financial instruments that pay interest. The non-availability of interest-free banking

products (where the return to the investor is tied to the bearing of risk, in accordance with

the principles of that faith) results in some Indians, including those in the economically

disadvantaged strata of society, not being able to access banking products and services

due to reasons of faith. This non-availability also denies India access to substantial

sources of savings from other countries in the region. While interest-free banking is

provided in a limited manner through NBFCs and cooperatives, the Committee

recommends that measures be taken to permit the delivery of interest-free finance on a

larger scale, including through the banking system. This is in consonance with the

objectives of inclusion and growth through innovation. The Committee believes that it

would be possible, through appropriate measures, to create a framework for such

products without any adverse systemic risk impact.

WEAKNESS

Indian banking laws do not explicitly prohibit Islamic banking but there are provisions

that make Islamic banking almost an unviable option. The financial institutions in India

comprises of Banks and Non Banking Financial Institutions. Banks in India are governed

through Banking Regulation Act 1949, Reserve Bank of India Act 1934, Negotiable

Instruments Act 1881, and Co-operative Societies Act 1961.

Certain provisions regarding this are mentioned below

55

Section 5 (b) and 5 (c) of the Banking Regulation Act, 1949 prohibit the banks to

invest on Profit Loss Sharing basis -the very basis of Islamic banking.

Section 8 of the Banking Regulations Act (BR Act, 1949) reads, "No banking

company shall directly or indirectly deal in buying or selling or bartering of

goods…"

Section 9 of the Banking Regulations Act prohibits bank to use any sort of

immovable property apart from private use –this is against Ijarah for home

finance

Section 21 of the Banking Regulations Act requires payment of Interest which is

against Shariah.

As regards to partnership by Islamic banks in a firm, the bank has to make sure that the

manager does not avoid his responsibilities or obtain other non-pecuniary benefits at the

expense of non-participating partners and ensure the veracity of the profit statements.

Monitoring of data about firms in which Islamic bank invests would involve exorbitant

cost. However, Islamic banks need to set up monitoring cell to keep them informed of the

internal function of their joint venture. The implication is that banks and entrepreneur

have to function very closely.

OPPORTUNITY

India with a 15% Muslim population, the highest in a non-Islamic country

and second highest in the world offers huge opportunities to exploit. The size of the

market will be very large as the Indian population is above 100 crore and Muslim

population itself is about 15 crore and majority of them, in the name of religious faith, are

looking for interest free banking and finance. It is pertinent to mention here that Islamic

banking is not meant for Muslims only but non Muslims may also avail the benefit of it.

And it is feasible to have a parallel banking system based on Shariah along with a

conventional one.

Eleventh Five Year Plan envisages inclusive growth with development in all sectors of

economy. Islamic banking is an effective mechanism to subjugate the liquidity and

inflation problems along with allowing inclusive growth. For real inclusive growth, we

have to ensure increase in income and employment status of workers in all segments.

If Islamic banking is introduced, the inadequate labor capital ratio, for informal sector

workers associated with agriculture and manufacturing industries could be resolved

through equity finance, which might be a revolution in our agriculture and unorganized

sector. With improved labor capital ratio, our vulnerable workers associated with

agriculture and unorganized sector might be able to compete effectively with the formal

sector workers. Thus Islamic Banking may financially empower majority of Indian

workers.

Islamic banking may induce our political leaders to substitute grants and subsidies with

equity finance schemes through specialized financial institutions because equity finance

allows access to credit without debts of borrowers. Equity Finance helps achieve self-

56

reliability which never comes through grant and subsidies. Islamic banking should not be

a religion based banking business, but could be profitably used to resolve our issues

pertaining to economy.

Moreover with introduction of Islamic banking, Indian government will certainly gain

diplomatic advantages to make financial dealings with Muslim dominated nations

especially to attract trillion dollars of equity finance from the gulf countries. This is more

important after the fall of the titans like Lehman Brothers because it reflects the economic

downturn in the west and the need of alternative sources of FDI for the Indian economy.

India needs to provide a congenial economic environment to attract the financial

inducement from the Gulf region.

Islamic scholars have defined market instruments in length and they have permitted with

some conditions to have investments in stock market .Certain broad criteria are:

The company's activities should not include liquor, pork, hotel, casino, gambling,

cinema, music, interest bearing financial institutions, conventional insurance

companies, etc.

The total interest bearing debt of the company at any point in time should remain

below one third of its average market capitalization during the last twelve months.

Its aggregate of account receivables should remain below 45% of total assets.

If company has any interest bearing income it should not be more than 10% in

any condition.

THREATS

Islamic banking could be a huge political issue. Certain parties might abhor the use of the

word "Islamic" and could term it as anti-Indian. They might argue that the very concept

of Shariah banking would go against the secular fabric of our country. We are already

facing problems pertaining to Muslim Personnel Law and trying to implement Uniform

Civil Code. Therefore, at this juncture, if we introduce Islamic banking in India, it will

create more problems than solving the issue. Moreover, it may bring financial segregation

in the economy. The compartmentalization of Shariah compliant and Non Shariah

Compliant banking might be used by certain vested interest to communalize the finance

sector in India. Such questionably sane but unquestionably dangerous trend must be

prevented with full might.

CONCLUSION

Islamic banking is at an incipient stage. The existing legal framework does not permit

Islamic Banking. Only selective activities like equity investment is possible, while trade

finance aspects like taking title to goods is not possible. A lot of amendments need to be

57

carried out in the prevalent legal set up. Appropriate models need to be selected and

implemented to suit society's diverse financial needs. Islamic Bank of Britain, Islamic

banks of Thailand, Singapore and USA may be glaring models for Indian bankers. The

reputed domestic and international banks along with the collaboration of RBI should be

involved in the process of determining and implementing Islamic Banking products.

The importance and relevance of Islamic banking in India in the context of "Financial

Tsunami" that has taken place in recent times further enhances the need of Shariah

banking. Also the political parties need economic rationality to convince majority of

voters that Islamic banking is not being introduced to please Muslim voters but to

genuinely boost faster and inclusive growth for the Indian economy. Obnoxious politics

in the name of religion must be avoided. I personally believe to refer 'Islamic Banking' as

'Interest Free Banking' so that it could be looked through the broad economic

kaleidoscope and not a narrow religious prism.

With only minor changes in their practices, Islamic banks can get rid of all their

cumbersome and sometimes doubtful forms of financing and offer a clean and efficient

interest-free banking. Participatory financing is a unique feature of Islamic banking, and

can offer responsible financing to socially and economically relevant development

projects. This is an additional service that Islamic banks offer over and above the

traditional services provided by conventional commercial banks. Such a system will offer

an effective banking system where Muslims in India may invest in pursuant to Islamic

principles and the rest may have an alternative to interest bearing conventional banking.

Both systems can co-exist. Let the people of the largest democracy decide democratically

which one they should bank upon. The young sapling of Islamic banking must be

nurtured by the Government so that the country may reap the benefit of its fruit in the

coming period.

58

Salman Khurshid assures cooperation for Islamic Banking

Submitted on 15 June 2009 -

By TwoCircles.net news desk

New Delhi: Salman Khurshid, Minister of State for Minority & Corporate Affairs,

assured to cooperate in the future programmes related to Interest-free Islamic

Banking. He expressed his opinion after his meeting with Mr. H Abdur Raqeeb,

Convener of the National Committee on Islamic banking, today.

Mr. Raqeeb, General Secretary of the Indian Centre for Islamic Finance (ICIF), met

with Mr. Khurshid to discuss about the feasibility of Interest-free Islamic Banking in

India.

“Islamic Banking will be beneficial to the Indian society, particularly for the

marginalized and the minorities, in terms of microfinance. It will also be beneficial in

major investments from the Gulf countries for massive infrastructural development as in

the case of the US $ 10 billion-project in the Economic Development Zone in

Maharashtra,” said Mr. Raqeeb. Exploring the possibility, he urged that if London,

Singapore, Tokyo and Hong Kong can become ‘the hub and house of Islamic Finance &

Banking’ then why not Mumbai and Kochi?

The following reports and documents about Islamic Banking in India were submitted

to Mr. Khurshid:

1. RBI Working Group Report to examine financial instruments used in Islamic Banking.

2. Report of the Dr. Raghuram Rajan Committee appointed by the Planning Commission

of India for Financial Sector Reforms –CFSR- submitted to the Prime Minister of India.

3. Lovell’s Document on Islamic Finance Regulations in Non-OIC Jurisdiction - in

countries like Britain, Singapore, Japan, Hong Kong, etc.

4. Financial Services Authority (FSA) Report on Islamic Finance in UK: Regulations and

Challenges.

5. Feasibility of Islamic Investment Company, KSIDC - Kerala State Industrial

Development Corporation- prepared by Ernst & Young.

6. Journey of Islamic Banking in India Power Point Presentation: Efforts undertaken

towards popularizing the concept of Islamic Banking among various segments and

stakeholders of Indian society.

59

India's first Islamic bank to start in Kerala by 2010

The first Islamic bank in the country with active involvement of the Kerala

government is likely to start operations in Kochi by next year as the bank's registration

formalities are currently being fulfilled on a war footing.

The Kerala industries department is actively involved in the new initiative and a high

level meeting held at Kozhikode on August 12 had approved a project report prepared by

Ernst & Young.

Kerala State Industrial Development Corporation, which is the designated agency for

the formation of the bank, will have 11 per cent stake in the proposed banking

company.

According to government officials in the know, it will be registered as a non-banking

finance company in the beginning and later get transformed into a full-fledged Sharai’ah-

compliant bank. It is likely that the registration formalities will be completed in the

current year itself and the NBFC will become operational in 2010.

The project proposes to raise an initial capital of Rs 500 crore (Rs 5 billion) from

leading non-resident Indians and Indian business houses. According to sources close to

the development, leading NRI businessmen such as Mohammed Ali, MA Yusuf Ali, CK

Menon and other Kerala-based industrialists such as Azad Mooppan have shown keen

interest in the venture.

Though an RBI study group had eariler rejected the concept of Islamic banking, it got

the backing of the Raghuram Rajan Committee on banking reforms. Purely based on

Sharai’ah principles, the bank will avoid interest-based business activities.

60

The proposed Kerala-based bank plans to invest funds in infrastructure projects, and two

areas, Bai al Salam and Instinsa, under Sharai’ah have been identified for such

investments.

The bank will invest all its funds in wealth generating investment avenues and will

distribute profit to its shareholders. The proposed Islamic bank will also set apart a social

fund, compulsory under Sharai’ah principles and the Islamic banking concept, and will

provide interest-free loans to the Gulf returnees to set up business or small scale ventures.

The concept is getting widespread support among the Muslim community of the state as a

large number of rich Muslims are strictly practicing Sharai’ah principles in business.

A major chunk of such persons do not have a bank account. A lot of discussion is also

going on whether investment in capital market is against Sharai’ah principles. A section

of the community believes that share trading is against the fundamentals of Islam. So the

formation of an Islamic bank will be a relief to them.

This concept is very popular in West Asia and in predominantly Muslim nations such as

Malaysia and Indonesia. Leading international banks such as HSBC and Standard &

Charted have exclusive Islamic banking windows.

According to sources, the biggest challenge before the Kerala-based bank will be the

formation of a Shariah Supervisory Board in order to monitor the activities of the

bank. The board should include independent scholars on Shari'ah and banking

business.

61

AMU to begin new course on Islamic banking

The Aligarh Muslim University (AMU) has decided to begin a course on 'Islamic

Banking and Finance', the first such course in India. The “interest free banking course” is

to be based upon the norms of 'Shariah' (Islamic rules on transaction).

A three-member committee has been formed under Dr Mohammad Nejatullah Siddiqi, a

retired AMU professor of Economics and Islamic Studies. Besides holding experience of

teaching Islamic Finance in various countries including Saudi Arabia and Malaysia, he

has been a consultant to a Los Angeles-based private firm, American Islamic Finance.

The Central Board of Secondary Education (CBSE) had recently asked the university to

start an undergraduate programme in marketing and finance.

Vice-Chancellor of the university, Prof Abdul Aziz, told The Indian Express: “Indian

banking system is gradually becoming aware of the Islamic banking. Indian students

should be exposed to the topic that holds considerable potential. We hope to begin the

course in the next academic session.”

Islamic law prohibits interest on both loans and deposits, as both profit and risk are

shared together by the borrower and the lender. As a result, the depositor, who does not

bear risk in other banking systems, has to equally share the risk with the bank in Islamic

banking. Owner of the capital, however, is allowed to have a share in the surplus.

Though there isn't any Islamic bank in India, there exist a few non-banking cooperatives

like Al Ameen Islamic Financial & Investment Corporation Ltd in Karnataka and

Mumbai-based Al-Barr Finance House Limited, which has branches in cities like Aligarh

and Chennai. There are also some popular investment companies like Parsoli Corporation

Ltd that claim to invest money as per the Islamic laws.

Experts feel that following a drift in US and European markets, India is seen as a

potential place for the Islamic banking, which can also attract NRI investors. “Some of

the top Indian companies are looking forward to launch Islamic financial products in the

country,” said Dr Siddiqi.

He said: “There lies a huge job opportunity in Islamic financing in India. Some private

institutions provide a few short-term courses, but the programme at the AMU will be

totally different.”

62

Delhi mulls Islamic banking

New Delhi, December 06: The government is considering changing banking law to

introduce an interest-free Islamic banking system in the country, sources said.

The Shariah prohibits the collection and payment of interest, so many Muslims now

avoid opening bank accounts or refuse to claim the interest, which goes to a suspended

account.

Under the Islamic banking system, banks don’t pay interests on deposits; nor do they

charge interest on loans. The money deposited is used to finance projects on ownership

basis. The depositors share in the profit or loss of the projects financed through their

deposits instead of getting interest.

For instance, in case of a housing loan, the bank buys the property and rents it out to the

borrower for a specified period of time. The rent is calculated on the basis of the cost of

the property plus a profit margin. After the lease term is over, the tenant gets ownership

of the property.

Under the existing banking system, only current accounts comply with Islamic banking

since these accounts don’t give any interest.

An Islamic bank, however, cannot invest the money just anywhere: the Shariah

prohibits investment in businesses considered haram, such as those related to alcohol,

pork or pornography.

An Islamic banking system will benefit India’s 15 crore Muslims, and also the

economy by helping unlock the huge sums that remain uninvested by the community.

Islamic banking is currently not allowed under India’s banking act, but it is allowed

through the non-banking financial institution route.

The Centre plans to amend the act, adding to it a chapter exclusively dealing with all

aspects of Islamic banking, sources said. It’s not clear if the amendment bill would be

tabled in the current session of Parliament. The sources said the government would form

a Shariah Supervisory Board to monitor the functioning of the Islamic banking system.

Finance minister Pranab Mukherjee has had discussions with the Reserve Bank of

India on the subject and obtained its approval, they said.

Although an RBI study group had earlier rejected the concept of Islamic banking, the

Raghuram Rajan Committee on banking reforms later gave a positive report on “interest-

free banking”. The minority ministry too is understood to be in favour.

63

There has been a strong demand for Islamic banking in India from various groups and

even the Gulf countries. The Muslim League has handed a memorandum to the Planning

Commission urging it to promote interest-free, profit-based banking.

The concept is popular in West Asia and predominantly Muslim nations such as Malaysia

and Indonesia. Leading international banks such as HSBC and Standard Chartered

have exclusive Islamic banking windows.

The Kerala Industrial Development Corporation recently launched an Islamic banking

company of sorts, which has been registered as a non-banking finance company and will

be transformed into a full-fledged Shariah-compliant bank once the banking regulations

allow it.

64

Australia

Islamic Investment Company, Melbourne.

Bahamas

Dar al Mal al Islami, Nassau

Islamic Investment Company Ltd, Nassau.

Masraf Faisal Islamic Bank & Trust, Bahamas Ltd.

Bahrain Albaraka Islamic Investment Bank, Manama.

Bahrain Islamic Bank, Manama.

Bahrain Islamic Investment Company, Manama.

Islamic Investment Company of the Gulf.

Masraf Faisal al Islami, Bahrain.

Denmark

Islamic Bank International of Denmark, Copenhagen.

Guinea Islamic Investment Company of Guinea, Conakry.

Masraf Faisal al Islami of Guinea, Conakry.

Kuwait Al Tukhaim International Exchange Company, Safat.

Kuwait Finance House, Safat.

Liberia African Arabian Islamic Bank, Monrovia.

Liechtenstein

Arinco Arab Investment Company, Vaduz.

Islamic Banking System Finance S.A. Vaduz.

Luxembourg Islamic Finance House Universal Holding S.A.

Malaysia

Bank Islam Malaysia Berhad, Kuala Lumpur.

Pilgrims Management and Fund Board, Kuala Lumpur.

Mauritania

Albaraka Islamic Bank, Mauritania.

65

Philippines Philippine Amanah Bank, Zamboanga.

Qatar

Islamic Exchange and Investment Company, Doha.

Qatar Islamic Bank.

Saudi Arabia

Albaraka Investment and Development Company, Jeddah.

Islamic Development Bank, Jeddah.

Senegal

Faisal Islamic Bank of Senegal, Dakar.

Islamic Investment Company of Senegal, Dakar.

South Africa

JAAME Ltd, Durban.

Sudan Bank al Baraka al Sudani, Khartoum.

Faisal Islamic Bank of Sudan, Khartoum.

Islamic Bank of Western Sudan, Khartoum.

Islamic Cooperative Development Bank, Khartoum.

Islamic Investment Company of Sudan, Khartoum.

Switzerland

Dar al Mal al Islami, Geneva.

Islamic Investment Company Ltd, Geneva.

Shariah Investment Services, PIG, Geneva.

Thailand Arabian Thai Investment Company Ltd, Bangkok.

Tunisia

Bank al Tamwil al Saudi al Tunisi.

Turkey Albarakah Turkish Finance House, Istanbul.

Faisal Finance Institution, Istanbul.

U.K. Albarakah International Ltd, London.

Albaraka Investment Co. Ltd, London.

Al Rajhi Company for Islamic Investment Ltd, London.

Islamic Finance House Public Ltd Co., London.

66

WEBSITES

www.hazariba.com

www.islamic-banking.com

www.islamicbanking.nl

www.feasta.org/documents/review2/carrie2.html

www.islamonline.net

www.arabianbussiness.com

www.TwoCircles.net

www.thestatesman.net

MAGZINE:

Islam, Muslim and World

BOOKS:

Muhammad Nejatullah Siddiqi (2004), Riba, Bank Interest, and The Rationale

of Its Prohibition

Muhammad Nejatullah Siddiqi Banking Without Interest